another forum thread asks this very question but didnt get into much depth (plain term descriptions) of the federal reserves inflationary mechanisms.
this link http://mises.org/Community/forums/p/2989/109799.aspx#109799
lists, which i assume are true ( i am not sure), three ways of federal reserve inflation.
the open market operation, the discount rate, and fractional reserve banking - which is i guess is a necessary mode of commercial banking that necessitates a central bank in the first place.
what i didnt see was the federal reserve/us treasury job of creation of currency.
what i believe is called the monetary base.
firstly, are there only four ways in which the federal reservve inflates the money supply?
i routinely see descriptions of the federal reserves activities called pumping or injecting.
are these legitimate descriptions?
increasing the monetary base seems like inflation proper - albeit done by a rather unaccountable organization such as a central bank. no market based risk to begin to produce money.
do the so called open market operations and discount rates more appropriatly create 'loans out of thin air' only to have much of the (virtual?) money retired soon thereafter?
from wiki "...rather than paper records such as banknotes, open market operations are conducted simply by electronically increasing or decreasing ('crediting' or 'debiting') the amount of money that a bank has, e.g., in its reserve account at the central bank, in exchange for a bank selling or buying a financial instrument. Newly created money is used by the central bank to buy in the open market a financial asset, such as government bonds, foreign currency, or gold . If the central bank sells these assets in the open market, the amount of money that the purchasing bank holds decreases, effectively destroying money.
The process does not literally require the immediate printing of new currency. A central bank account for a member bank can simply be increased electronically."
http://en.wikipedia.org/wiki/Open_market_operations
is the wiki description true? if what is described at wiki is true, is the inflation that is spoken of on the previous thread usually followed by a deflation of a similar amount?
does the omo simply facilitate bank asset sales or that would likely not have taken place?
does it provide a regular instant source of non-saved money to continually correct bank goof-ups?
additionally on the wiki site "How open market operations are conducted in the USA
In the U.S., the Federal Reserve (Fed) most commonly uses overnight repurchase agreements (repos) to temporarily create money, or reverse repos to temporarily destroy money...."
this seems arcane to me.
the discount rate i understand even less.
i can see how the fractional reserve aspect (if it actually takes place) of commercial banking creates a spendable loan check, spendable reserves and spendable claims on money - nearly doubling spending opportunities and i would assume raising prices higher than they would have been.
does the money doubling effect on prices however, level off after time?
and finally, could someone here please explain if the omo and discount rate truly operate in an inflationary way or are they rather benign when it comes to money supply increases of the sort that make their way into pushing up price levels.
please..no replies from jon irenicus
thanks
sthomper
on the federal funds rate, wiki states "In the United States, the Fed Funds Rate is the interest rate at which private depository institutions (mostly banks) lend balances (federal funds) at the Federal Reserve to other depository institutions, usually overnight.[1] It is the interest rate banks charge each other for loans.[2] Changing the target rate is one way the Chairman of the Federal Reserve can influence the supply of money in the U.S. economy.[3]. The Federal funds target rate is determined by a meeting of the members of the Federal Open Market Committee which occurs every two months."
then....
"The bank can borrow the requisite funds from another bank that has a surplus in its account with the Fed. The interest rate that the borrowing bank pays to the lending bank to borrow the funds is negotiated between the two banks...."
"Interbank borrowing is essentially a way for banks to quickly raise capital. For example, a bank may want to finance a major industrial effort but not have the time to wait for deposits or interest (on loan payments) to come in."
"Another way banks can borrow funds to keep up their required reserves is by taking a loan from the Federal Reserve itself at the discount window."
this wiki entry seems confusing to me because i cannot see where, with the exception of the discount window mentioned above, how interbank bank lending for surples reserves held at teh federal reserve 'inflates' the money supply.
wiki says of the discount window - "It is distinct from the federal funds rate or its equivalents in other currencies, which determine the rate at which banks lend money to each other. In recent years, the discount rate has been approximately a percentage point above the federal funds rate (see Lombard credit). Because of this, it is a relatively unimportant factor in the control of the money supply ..."
for clarification...if according to wiki, the discount window (if it truly exists) doesnt affect the money supply in any significant way...and as i understand it, the federal funds rate only 'regulates' interbank lending....how does the fed funds rate affect inflation?
was there something in the wiki article that i am missing?
OMOs can involve buying or selling assets. When the Fed buys assets it pushes money into the market to do so and when it sells assets it takes money out of the market in doing so... as such OMOs can technically be inflationary or deflationary and they will be one or the other depending on whether the Fed is trying to push interest rates up or down, among other things. Over the long term, all monetary policy (OMOs included) have invariably proved to be used to inflate rather than to deflate or even keep a stable money supply.
I don't think you're using the term "monetary base" correctly... you seem to be using this to mean physical cash - which is not how it is commonly used.
You should read through the following: Our Financial House of Cards
That should give you a good idea of how things work... at least at a "birds eye view" level. After having read through that you should be better placed to ask specifics.
When it comes to it, I still have a few questions of my own on this topic - it seems shrouded in complexity.
wiki says of the 'federal funds rate'....."Fed Funds Rate is the interest rate at which private depository institutions (mostly banks) lend balances (federal funds) at the Federal Reserve to other depository institutions, usually overnight.[1] It is the interest rate banks charge each other for loans.[2] Changing the target rate is one way the Chairman of the Federal Reserve can influence thesupply of money in the U.S. economy.[3
and....
"If its reserve ratio drops below the legally required minimum, it must add to its reserves to remain compliant with Federal Reserve regulations. The bank can borrow the requisite funds from another bank that has a surplus in its account with the Fed. The interest rate that the borrowing bank pays to the lending bank to borrow the funds is negotiated between the two banks, and the weighted average of this rate across all such transactions is the federal funds effective rate."
"Another way banks can borrow funds to keep up their required reserves is by taking a loan from the Federal Reserve itself at the discount window. Another difference is that while the Fed cannot set an exact federal funds rate, it can set a specific discount rate."
http://en.wikipedia.org/wiki/Federal_funds_rate
again, i am mostly unfamiliar with the federal reserve and its operations...but if the above information form wiki describes actual federal reserve procedures, i dont see how the federal funds rate contributes to inflation if it just regulates inter-bank loans drawn from surplus accounts at the federal reserve ( i assume fed means federal reserve).
is there something that i am missing when the federal reserve sets a funds rate that differs from what the excerpt from wiki says?
wiki then says of the discount window at the 'federal reserve' -- "the interest rate charged on such loans by a central bank is called the discount rate, base rate, repo rate, or primary rate. It is distinct from the federal funds rate or its equivalents in other currencies, which determine the rate at which banks lend money to each other. In recent years, the discount rate has been approximately a percentage point above the federal funds rate (see Lombard credit). Because of this, it ( the discount rate) is a relatively unimportant factor in the control of the money supply...."
http://en.wikipedia.org/wiki/Discount_window
can anyone confirm this information?
i was using the term monetary base to mean roughly....
"M0 -- currency (notes and coins) in circulation and in bank vaults, plus reserves which commercial banks hold in their accounts with the central bank (minimum reserves and excess reserves). M0 is usually called the monetary base - the base from which other forms of money (like checking deposits, listed below) are created - and is traditionally the most liquid measure of the money supply.[7]"
http://en.wikipedia.org/wiki/Money_supply
meaning money inflation similar to this
"As far as I know, the Treasury Department runs the printing press. They sell the FED the paper currency at something like $.06 per note"
http://mises.org/Community/forums/p/2048/26703.aspx
sthomper: i was using the term monetary base to mean roughly.... "M0 -- currency (notes and coins) in circulation and in bank vaults, plus reserves which commercial banks hold in their accounts with the central bank (minimum reserves and excess reserves). M0 is usually called the monetary base - the base from which other forms of money (like checking deposits, listed below) are created - and is traditionally the most liquid measure of the money supply.[7]" http://en.wikipedia.org/wiki/Money_supply
OK, understood. If you look at http://www.mises.org/markets.asp you'll see a graph there for the St Louis Adjusted Monetary Base. This graph is, obviously, not a chart of the quantity of physical notes and coins... rather it includes commercial reserves with the central bank.
See: http://en.wikipedia.org/wiki/Monetary_base
Basically it is these reserves that form the basis for the loans that the commercial banks can extend.
The Fed can control the quantity of reserves in the system through the OMOs. The commercial banks then pyramid off the back of this... making home loans etc. (which is where the majority of inflation comes from).
Only a very small portion of the "money" in the economy takes the form of notes and coins and, similarly, only a very small portion of the inflation that takes place concerns inflation of the physical media.
sthomper: again, i am mostly unfamiliar with the federal reserve and its operations...but if the above information form wiki describes actual federal reserve procedures, i dont see how the federal funds rate contributes to inflation if it just regulates inter-bank loans drawn from surplus accounts at the federal reserve ( i assume fed means federal reserve). is there something that i am missing when the federal reserve sets a funds rate that differs from what the excerpt from wiki says?
The method that they use to "set" the FFR... basically if the current rate that banks charge one another averages 5% and the Fed wants it to be 4.5% (i.e. they target 4.5%) then the way they get the interest rate down is buy boosting supply of the funds that can be loaned. This is achieved indirectly by purchasing assets in the open market (via the OMOs). The result will be that more money will find it's way into the coffers of the commercial banks that hold balances with the Fed. To the extent that those commercial banks are not able to extend loans on the basis of this money themselves, they will (ordinarily) lend it to other commercial banks and the greater the quantity of funds there is to be loand the lower the interest rates that these will be able to attract.
So the inflation is two-fold. Firstly, the Fed pushes new reserves into the system via the OMOs in order to try to bring the FFR down. Secondly the commercial banks pyramid loans on the basis of those reserves. So normally if the Fed increases the monetary base (not typically notes and coins but more commonly by increasing the total quantity of reserves in the system held on account with the Fed itself) by 100 billion you might expect an actual expansion of the overall money supply of maybe 1 trillion (in a very simple example).
"....then the way they get the interest rate down is buy boosting supply of the funds that can be loaned. This is achieved indirectly by purchasing assets in the open market (via the OMOs). The result will be that more money will find it's way into the coffers of the commercial banks that hold balances with the Fed."
can we agree that the wiki entry doesnt say this at all??
and the indirect purchases you mentioned...how are these purchases made? through direct 'money' creation - is the inflationary aspect of the federal reserves 'lowering' the federal runds rate?
let me see...the federal reserve will desire a speific interest rate that it wants the banks to lend to each other at...which seems f**ked up anyway. to achieve this specific rate the fed will create (billions??) money to buy assets held by and normally purhcased by commercial banks -- to......keep the banks from having to loan at higher rates to aquire these assets?????
is this correct??
is this the most inflationary thing the federal reserve does???
U.S. banks and thrift institutions are obligated by law to maintain certain levels of reserves, either as reserves with the Fed or as vault cash. The level of these reserves is determined by the outstanding assets and liabilities of each depository institution, as well as by the Fed itself, but is typically 10%[4] of the total value of the bank's demand accounts (depending on bank size).
"a particular U.S. depository institution, in the normal course of business, issues a loan. This dispenses money and decreases the ratio of bank reserves to money loaned. If its reserve ratio drops below the legally required minimum, it must add to its reserves to remain compliant with Federal Reserve regulations. The bank can borrow the requisite funds from another bank that has a surplus in its account with the Fed. "
the impression i get from the wiki excerpt is the the federal runds rate is primarilly used to setlle a banks deficient reserve ratio due to one too many loans??
you say here....."basically if the current rate that banks charge one another averages 5% and the Fed wants it to be 4.5% (i.e. they target 4.5%) then the way they get the interest rate down is buy boosting supply of the funds that can be loaned. "........"To the extent that those commercial banks are not able to extend loans on the basis of this money themselves, they will (ordinarily) lend it to other commercial banks ...."
i am not quite sure what you mean by 'banks are not able to extend loans' and 'they lend it to ther commercial banks'.
the wiki article says nothing of omo asset purchases...only interbank loans to satisfy a reserve requirement or internbank loans (which i assume partially come from a surplus at the federal reserve) or "Interbank borrowing is essentially a way for banks to quickly raise capital. For example, a bank may want to finance a major industrial effort but not have the time to wait for deposits or interest (on loan payments) to come in. In such cases the bank will quickly raise this amount from other banks at an interest rate equal to or higher than the Federal funds rate."
again...is the wiki article leaving out important information (under its mechanism heading) with regard to the federal funds rate.
sthomper:can we agree that the wiki entry doesnt say this at all??
I didn't see it on the page you linked to no...
sthomper:and the indirect purchases you mentioned...how are these purchases made? through direct 'money' creation - is the inflationary aspect of the federal reserves 'lowering' the federal runds rate?
This is not going to be a precise/textbook explanation but here goes...
If the market rates are above the Fed's target (FFR) then I believe the Fed direct's a bunch of banks known as the "primary dealers" to purchase securities from the market using Federal Reserve funds... the equivallent of a check written against the Federal Reserve. The primary dealers buy these assets (typically government bonds) and whoever takes the check can then go and deposit it. Say it's presented to Bank of Orion, the Bank of Orion presents it to the Fed and the Fed credits the Bank of Orion's accounts at the Federal Reserve with the new funds. Howevere there is not, at any stage, a corresponding debit - the money that goes into the Bank of Orion's account has thus 'sprung out of thin air' (an expression you'll no doubt be familiar with) - it did not exist anywhere in the financial system before it appeared in the bank account of the commercial bank that presented the Fed's check.
I'm not sure that physical checks would be used these days - probably they are not... but that's conceptually that's what's going on.
Whether the Fed could be said to be inflating the monetary base or not by lowering or raising interest rates depends entirely on what the market rate wants to be. If the Fed targets a rate below market rate then they will need to push reserves into the system in order to maintain their target. If they target a rate that is above market rate then, quite to the contrary, they will need to destroy money (pulling it out of the system) in order to maintain their target. The later doesn't happen very often but can do, when inflation is really getting out of control... more generally, the Fed tries to inflate.
sthomper: is this correct?? is this the most inflationary thing the federal reserve does???
Pretty much... although it's hard to say who would have purchased the asests if the Fed didn't - it might not have been the commercial banks. None the less, the Fed crowds out private investors yeah - pushing down yeilds on investment opportunities that would otherwise be there for private capital and discouraging savings by driving down interest rates.
This is perhaps not the most inflationary thing the Fed does... they also act as a lender of last resort and do a million and one other things these days, so it's very hard to tell. The FDIC has its share of the blame as well, since without the FDIC bank runs would be a yearly event with current reserve ratios... and of course government is behind it all (providing the legal backing for the operation and also continually running deficits and selling bonds to the Fed).
The entire financial system, for all its complexity, is really just a giant wealth redistribution machine... with the primary beneficiaries being the banking industry and government (who have a guaranteed buyer for their debt - namely the Fed - allowing them to run deficits until the cows come home... which is basically how the system sprung up - the Brittish government needed cash to fight some war with the French back in the 1600s but none of the private investors would buy their bonds because they'd all lost too much money lending to the government during the previous war).
sthomper:the impression i get from the wiki excerpt is the the federal runds rate is primarilly used to setlle a banks deficient reserve ratio due to one too many loans??
No that's another beast - it's called the Discount Window or the Discount Rate in the U.S. (the Overnight Cash Rate in some other countries). It's basically overnight lending directly to banks when they're not able to borrow from other banks for some reason... but the Fed prefers them to borrow from other banks at the FFR so the Discount Rate will typically be slightly higher than the FFR.
sthomper:i am not quite sure what you mean by 'banks are not able to extend loans' and 'they lend it to ther commercial banks'.
So if a bank is sitting on 1 billion in deposits but only has 800 million in loans, they could technically lend out another 100 million... it's just sitting there idle. If they can't find would be home owners to lend to or would be business startups or whatever, since they've got nothing else to do with the cash they typically try to lend it to another commercial bank that maybe has 1 billion in deposits, 900 million in loans and actually has a bunch of people that want to borrow for them but doesn't have the reserves to cover such loans...
When two commercial banks lend/borrow between one another in this manner they will agree upon a price (an interest rate that will be paid for the loan) and it is the average of these interbank lending rates that form the target of the FFR... it is these interest rates that the Fed tries to bring inline with the FFR in performing their open market operations.
sthomper:again...is the wiki article leaving out important information (under its mechanism heading) with regard to the federal funds rate.
Yeah, I've had trouble digging up information on this topic more generally. I'm thinking a text book on central banking or something might be what you're after (man would that be one boring read though).
sthomper: the impression i get from the wiki excerpt is the the federal runds rate is primarilly used to setlle a banks deficient reserve ratio due to one too many loans??
"No that's another beast - it's called the Discount Window or the Discount Rate in the U.S."
yes....i read about the discount window at another wiki entry site however this wiki link http://en.wikipedia.org/wiki/Federal_funds_rate specifcally for the 'federal funds rate' says in the first line "In the United States, the Fed Funds Rate is the interest rate at which private depository institutions (mostly banks) lend balances (federal funds) at the Federal Reserve to other depository institutions, usually overnight.[1] It is the interest rate banks charge each other for loans.[2] "
this link here http://en.wikipedia.org/wiki/Federal_funds_rate
the same just a few lines up says of the discount rate "Another way banks can borrow funds to keep up their required reserves is by taking a loan from the Federal Reserve itself at the discount window. These loans are subject to audit by the Fed, and the discount rate is usually higher than the federal funds rate. Confusion between these two kinds of loans often leads to confusion between the federal funds rate and the discount rate. Another difference is that while the Fed cannot set an exact federal funds rate, it can set a specific discount rate."
the wiki entry for the 'federal funds rate' mentions the 'discount rate' as just being another way banks can borrow funds to maintain reserves.
when i earlier said "the impression i get from the wiki excerpt is the the federal runds rate is primarilly used to setlle a banks deficient reserve ratio due to one too many loans??"
your reply was "No that's another beast - it's called the Discount Window...."
wiki says "In the United States, the Fed Funds Rate is the interest rate at which private depository institutions (mostly banks) lend balances (federal funds) at the Federal Reserve to other depository institutions, usually overnight.[1]...
"U.S. banks and thrift institutions are obligated by law to maintain certain levels of reserves.....If its reserve ratio drops below the legally required minimum, it must add to its reserves to remain compliant with Federal Reserve regulations. The bank can borrow the requisite funds from another bank that has a surplus in its account with the Fed. The interest rate that the borrowing bank pays to the lending bank to borrow the funds is negotiated between the two banks, and the weighted average of this rate across all such transactions is the federal funds effective rate.
the above information is stated here... http://en.wikipedia.org/wiki/Federal_funds_rate
is wiki mistating the the function of the federal funds rate?
you claim the discount window is what settles inter bank loans to meet reserve requirements.....wiki states the discount window is just another way of doing this.
is the wiki entry incorrect?
They're both loans to covere a shortfall in reserves... just from different people and at different rates. The Fed controls the FFR indirectly and the Discount Rate directly. Both types of loans add new reserves to the system...
AFAIK, discount window is not available to everyone, just commercial banks. Though lot has been changed lately, it was extended to investment banks also. DW rate is set slightly above FFR, because FED doesn't want effective rate to overshoot much. DW was rarly used until lately. The idea is if there is shortage of liquidity in the system, banks would go to DW instead of raising rates above target rate. OMO is primary source of controlling FFR. DW is just additional insurance rates won't go much above FFR.
ok.
i am unfamiliar with many of these terms but my desire was to get an understanding of the ways the federal reserve specifically inflates the money supply through procedures that i have read about -- the federal funds rate, the discount window, fractional reserve banking and the federal reserve working in concert with the treasure to increase currency.
all i have thus far to go by is descriptions on the wikipedia site and comparing that information to replies that i get on this thread.
poster jimmy has provided some additional information about the federal runds rate that the wikipedia site did not have but that i havent confirmed elsewhere.
another thread with the same name as this one asked similar questions about the federal reserves inflationary procedures. i was just unsatisfied with the replies.
as i have posted several times, this wiki link says that the FEDERAL FUNDS RATE " the interest rate at which private depository institutions (mostly banks) lend balances (federal funds) at the Federal Reserve to other depository institutions, usually overnight.[1] It is the interest rate banks charge each other for loans.[2] Changing the target rate is one way the Chairman of the Federal Reserve can influence thesupply of money in the U.S. economy.[3]."
but nowhere at teh wiki site does it describe how the money supply is inflated - merely that it is the rate that banks lend to each other.
i am still trying to digest poster jimmys additional description on how the federal funds rate infaltes money supples - to see if it is a detriment to those outside the banking sphere.
the wikipedia link referencing the "FEDERAL FUNDS RATE" says this about the discount rate or window "Another way banks can borrow funds to keep up their required reserves is by taking a loan from the Federal Reserve itself at the discount window. These loans are subject to audit by the Fed, and the discount rate is usually higher than the federal funds rate. Confusion between these two kinds of loans often leads to confusion between the federal funds rate and the discount rate. Another difference is that while the Fed cannot set an exact federal funds rate, it can set a specific discount rate."
this link
specifically refernces the discount window at the federal reserve. for instance -- "The interest rate charged on such loans by a central bank is called the discount rate, base rate, repo rate, or primary rate. It is distinct from the federal funds rate or its equivalents in other currencies, which determine the rate at which banks lend money to each other. In recent years, the discount rate has been approximately a percentage point above the federal funds rate (see Lombard credit). Because of this, it is a relatively unimportant factor in the control of the money supply and is only taken advantage of at large volume during emergencies."
if the information posted above concering the DISCOUNT RATE is legitmate and not false, it would seem that the discount has little effect on monetary inflation and differs from the FEDERAL FUNDS RATE because " The discount window is an instrument of monetary policy (usually controlled by central banks) that allows eligible institutions to borrow money from the central bank ...........it is distinct from the federal funds rate or its equivalents in other currencies, which determine the rate at which banks lend money to each other."
FEDERAL FUNDS RATE...somewhat set by the federal reserve to regulate loans between banks. the discount window, though seldom used, allowes banks to get loans directly from the central bank.
again, this is according to wikipedia and i assume isnt false or untrue information.
poster jimmy seems to agree with it in part.
poster jimmy also mentions open market operations conducted by the federal reserve (the same thing as what i read sa being called the FED, correct me if i am wrong here).
wikipedia one again says....."Since most money is now in the form of electronic records, rather than paper records such as banknotes, open market operations are conducted simply by electronically increasing or decreasing ('crediting' or 'debiting') the amount of money that a bank has, e.g., in its reserve account at the central bank, in exchange for a bank selling or buying a financial instrument[respectively?]. Newly created money is used by the central bank to buy in the open market a financial asset, such as government bonds, foreign currency, or gold. If the central bank sells these assets in the open market, the amount of money that the purchasing bank holds decreases, effectively destroying money."
open market operation, if legitmate, would seem to be an inflationary mechanism performed by the federal reserve.
poster jimmy stated the federal reserves tendency in this area has been inflationary - i am just trying to find out how much, and if there have been real deflationary trends at all.
i keep reading of the federal reserves 'inflating' or 'pumping' of the money with very little description of what actually takes place.
if you can elaborate on these wikipedia descriptions that would be helpful - or -reccomd a textbook that describes these process in written and visual format.