Foreign Exchange Rate Intervention and the Monetary Base

Study Guide

It is not to understand how each of the following factors affects the monetary base if you work through the effects of a particular transaction on the T-account of each individual or institution in the transaction. Having done this, you will know what has happened to reserves or to currency and can then see what has happened to the monetary base. To test your understanding, work through what happens to the T-accounts when the factor falls rather than rises.

Factors That Affect the Monetary Base

As we examine the effect of changes in each factor on the monetary base, we assume that there are no changes elsewhere in the Fed’s balance sheet. Let us look first at the factors whose increase adds to the monetary base.

Factors That Add to the Monetary Base

Securities and discount loans Since we have already described in detail how changes in discount loans and the Fed’s holding of securities via open market operations affect the monetary base in Chapters 14 and 15, we only restate our conclusions here. An increase in the Fed’s holding of securities or in discount loans leads to an equal increase in the monetary base (as shown in Table 18.2).

Gold and SDR Accounts and Other Federal Reserve Assets A Fed purchase of gold, SDRs, a deposit denominated in a foreign currency or any other asset is just an open market purchase of these assets. Thus the effect on the monetary base is the same as an open market purchase of bonds (as Box 18.1 demonstrates). An increase in gold and SDR accounts or in the other Federal Reserve assets leads to an equal increase in the monetary base.

Float As shown in Chapter 9, the Federal Reserve’s check-clearing process involves a deposit of a check received by a bank into its Fed account, a credit of the amount of its check to its reserves, and equal debit to the reserves of the bank on which the check is drawn. We might assume that these transactions all occurred simultaneously and immediately, but in reality, the Fed frequently credits the amount of a check to a bank that has deposited it (increases the bank’s reserves) before it debits (decreases the reserves of) the

A Global Perspective

Foreign Exchange Rate Intervention and the Monetary Base

It is common to read in the newspaper about a Federal Reserve intervention in the foreign exchange market to buy or sell dollars. Can this also be a factor that affects monetary base? The answer is "yes", because a Federal Reserve intervention in the foreign exchange market involves a purchase or sale of assets denominated in a foreign currency, which is included in the other Federal Reserve assets category in the Fed’s balance sheet.

Suppose the Fed purchases $10 million of deposits denominated in French francs in exchange for $10 million of dollar deposits at the Fed (called a sale of dollars for francs). As discussed in the text, a Federal Reserve purchase of any asset, whether it be a U.S. government bond or a deposit denominated in a foreign currency, is just an open market purchase and so leads to an equal rise in the monetary base. Hence the purchase of the $10 million in franc deposits leads to a $10 million increase in other Federal Reserve assets and a $10 million increase in the monetary base. Similarly, a sale of foreign currency deposits leads to a decline in the monetary base. Federal Reserve interventions in the foreign exchange market can thus be an important influence on the monetary base, a topic that we discuss further in Chapter 21.

bank on which the check is drawn. The resulting net increase in the total amount of reserves in the banking system is called float, and it equals the difference between the asset, cash items in process of collection (checks on which the Fed has not yet collected payment) and the liability, deferred availability cash items (checks that have not yet been credited to the bank depositing them).

Float occurs because sometimes the Fed cannot present checks for payment as fast as it credits the bank depositing the check; float fluctuates when weather conditions and other factors cause delays in presenting checks for payment. If, for example, a severe snowstorm hits New York City, the Fed will not be able to move some checks that it wants to present for payment, and float will rise sharply. When the weather clears, the checks will be presented for payment and float will fall back down again.

To better understand the concept, let’s return to our example (Chapter 9) in which Jane Brown takes a $100 check written on an account at the Second National Bank in Los Angeles and deposits it in her account at the First National bank in New York City. The First National Bank takes the check to the Fed for clearing, with the following effect on the Fed balance sheet:

The $100 of deferred availability cash items is the liability incurred by the Fed when it accepts the checks from the First National Bank, because it promises to credit the First National Bank with $100 of deposits within a certain prearranged time limit (never exceeding two days). The $100 of cash items in the process of collection is a Fed asset, because the Fed will deduct this amount from the Second National Bank’s deposits when it presents the check to Second National Bank for payment.

At this point reserves have not changed anywhere in the banking system, and since cash items in process of collection equals deferred availability cash items, their difference - equal to float – is also unchanged. Because of possible delays due to bad weather conditions, the Fed may not able to move the check to Los Angeles before the prearranged time limit is up. However, it still dutifully does as it promised and credits the First National Bank with $100 of deposits (reserves) and cancels out its liability of $100 of deferred availability cash items. The Fed’s T-account now becomes

Float, the difference between cash items in process of collection ($100) and deferred availability cash items ($0), is now +$ 100, and reserves in the banking system have also increased by this same amount. What has happened is that the Fed has not yet been able to collect what is owed by the Second National Bank but has credited the First National bank anyway. The result is that, in effect, the Fed has extended First National Bank an interest-free loan equal to the amount of the float, thus raising reserves and hence the monetary base.

This "loan" will be only temporary, however, because when the Fed finally gets the check to Los Angeles and Presents it to the Second National Bank, it deducts $100 from the Second National Bank’s deposits (reserves) and cancels out the $100 of cash items in process of collection. The Fed’s T-account ends up as follows:

The end result of the check-clearing process is that total reserves in the banking system have not changed, even though reserves have moved from one bank to another. In the process of clearing the Second National Bank’s check, however, reserves and the monetary base have been temporarily increased. If you multiply these temporary increases in the monetary base by the millions of checks cleared per day, it can lead to sizable week-to-week fluctuation in the monetary base. Yet since most fluctuations in float are temporary, they are not a major source of fluctuations in the monetary base over longer periods of time (such as a month or three month).

Our conclusion from the manipulations of these T-accounts is consistent with Table 18.2: An increase in float leads to an equal increase in the monetary base.

Treasury Currency Outstanding Although this term is not on the Federal Reserve’s balance sheet, it still has an effect on the monetary base. An increase in Treasury currency outside the Treasury finds its way either into bank vaults (where it counts as reserves) or into the hands of the public (where it counts as currency in circulation). Thus, as Table 18.2 indicates, the monetary base rises when there is an increase in Treasury currency outstanding.

Поиск по сайту: