A closer look at the Federal Reserve and its impact on the markets “Those who cannot remember the past... are condemned to repeat it”
-George Santayana
Santayana, George. Reason in Common Sense. New York: Dover Publications, 1980. Print. Fed Funds Rate Inflation .38% .26% + 1.60% +2.65% 1.98% 2.91% Current: 1.69% As of 9/12/2016 As of 09/30/15
• Price Stability/Inflation
• Employment
• Rate Stabilization/Manage Bubbles
1. Fractional Reserve Requirements 2. Excess Reserves 3.The Money Multiplier 4. The Velocity of Money 1. Fractional Reserve Requirements
Percentage of cash the bank has to keep on hand as a percentage of deposits 1907
• No central bank (Federal Reserve) in America
• Knickerbocker Trust loaning out 99% of its reserves
• Run on banks
• Banks did not have enough cash on reserves
• JP Morgan bailed out the banking system 1910
• 6 influential banking leaders get together on Jekyll Island, GA • First U.S. Central Bank (Federal Reserve) was created • Banks had a bad name, so they called it the Federal Reserve to make it sound official • All banks have to play by the same rules…every bank has to keep the same percentage of deposits on hand Operated the same until 2008 10% 13% 1. Fractional Reserve Requirements 2. Excess Reserves
Reserves held beyond the fractional reserve requirement $100 B $12 B On Reserve
$100 B FRR 10% $10 B Required
$100 B $2 B Excess Reserve
$100 B 1. Fractional Reserve Requirements 2. Excess Reserves 3.The Money Multiplier
Measurement of change in the country’s money supply based on the FRR $100
$90 10%
$81 10%
$7290 10% Ratio 1:FRR
10% FRR / MM 10x
$100 Ratio 1:FRR
10% FRR / MM 10x
13% FRR / MM 8x
$100 1. Fractional Reserve Requirements 2. Excess Reserves 3.The Money Multiplier 4. The Velocity of Money
Rate at which money goes from one transaction to another in an economy. 2.30
2.20
2.10
2.00
1.90
1.80
1.70
1.60
1.50 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2.30
2.20
2.10 • Recency Bias - Less of an Appetite to Lend/Borrow 2.00 • Regulations 1.90 • Incentive – Interest on Reserves 1.80
1.70
1.60
1.50 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015
“The Fed was largely responsible for converting what might have been a garden- variety recession... into a major catastrophe.” -Milton Friedman Economist, Nobel Memorial Prize Winner in Economic Sciences
Friedman, Milton, and Rose D. Friedman. Two Lucky People: Memoirs. Chicago: U of Chicago, 1998. Print. “I would like to say to Milton and Anna: Regarding the Great Depression. You're right, we did it. We're very sorry. But thanks to you, we won't do it again.” -Ben Bernanke Former Fed Chairman
Source: http://www.federalreserve.gov/BOARDDOCS/SPEECHES/2002/20021108/
1934 17% 1935 11%
1933 -4% 1930 -12% 1931 -16% 1932 -23% Nov. 1934
Marriner Eccles becomes new Fed Chairman 1935
$3 Billion in required reserves
$3 Billion in excess reserves
US GDP: $48 Billion Fractional Reserve Which resulted in a How much was in Requirement in 1935? money multiplier of… excess reserves?
13% 8x $3B Marriner Eccles is concerned that the economy is growing too fast… and he wants to slow it down…. what does he do? 1937
He does NOT increase the Fed funds rate 13% 26% FRR FRR He wanted to eliminate the excess liquidity 30%
20%
10%
0% 1938 – Recession -10%
-20%
-30% 1930 1931 1932 1933 1934 1935 1936 1937 1938 Two workers carry the Lehman Brothers corporate logo away Sept. 24, 2010, in London, England. (Oli Scarff/Getty Images) 2008
Financial Services Regulatory Relief Act goes into effect . Congress allows the Fed to pay interest on required reserves AND excess reserves
Roughly $1.6 billion in excess reserves and roughly $68 billion in required reserves. $4.50
$4.00 Trillions
$3.50
$3.00
$3.2 $2.50 Trillion $2.00
$1.50
$1.00
$0.50
$0.00 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14
Source: Board of Governors of the Federal Reserve System (US) Why have Where Did we not seen All the any Money Go? inflation? 2.00
1.80 Trillions
1.60
1.40 $2.58 1.20 Trillion 1.00 0.80
0.60
0.40
0.20
0.00 1980 1985 1990 1995 2000 2005 2010 2015
Source: Board of Governors of the Federal Reserve System (US) What is Inflation?
When was the first period of recorded inflation?
Germany, 1921 1921 1922 1923
Interest on Reserves 0 bp 50 bp 100 bp
Reverse Repo Rate Macroprudential “I think we have plenty of tools now at this point” -Ben Bernanke Former Fed Chairman 2006-2014
Source: http://www.brookings.edu/~/media/events/2014/1/16%20central%20banking%20great%20recession/20140116_bernanke_remarks_transcript.pdf Fractional Reserve Requirement FFR Under the Corridor Set Federal Funds Rate System
T-Bills Interest on Reserves
Reverse Repurchase Rate
Macroprudential
6
5
4
3
2
1
0
-1
-2
-3 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Source: Bloomberg as of 6/30/16 18
16
14
12 U3 10 8
6
4
2
0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Source: Bloomberg as of 6/30/16 18
U6 16
14
12 U3 10 8
6
4
2
0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Source: Bloomberg as of 6/30/16 “Two of the Fed’s most important new tools [are] our authority to pay interest on excess reserves and our asset purchases…our ability to use interest on reserves is likely to play a key role for years to come.” Janet Yellen Fed Chairwoman Remarks from Jackson Hole Symposium August 26, 2016 Slow Tightening Cycles All Tightening Cycles
Fast Tightening Cycles Fractional Reserve Which results in a money Requirement today? multiplier of…
10% 10x $2.58 Trillion $25.8 Trillion $17 Trillion Excess Reserves Potential Money U.S. GDP Thank You
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