VIII. Summarize the following passage in about 100 words and give an appropriate title

As the preceding discussion illustrates, monetary policy works through the market for reserves and involves the federal funds rate. A change in the reserves market will trigger a chain of events that affect other short-term interest rates, foreign exchange rates, long-term interest rates, the amount of money and credit in the economy, and levels of employment, output, and prices. For ex­ample, if the Federal Reserve reduces the supply of reserves, the resulting increase in the federal funds rate tends to spread quickly to other short-term market interest rates, such as those on Trea­sury bills and commercial paper. Because interest rates paid on many deposits in the money stock adjust only slowly, holding balances in money (that is, in a form counted in the money stock) becomes less attractive. As the public pursues higher yields avail­able in the market (for example, on Treasury bills), the money stock declines. Moreover, as bank reserves and deposits shrink, the amount of money available for lending may also decline. Higher costs of borrowing and possible restraints on credit supply will damp growth of both bank credit and broader credit measures.

A change in short-term interest rates will also translate into changes in long-term rates on such financial instruments as home mortgages, corporate bonds, and Treasury bonds, especially if the change in short-term rates is expected to persist. Thus, a rise in short-term rates that is expected to continue will lead to a rise (though typically a smaller one) in long-term rates.

Higher long-term interest rates will reduce the demand for items that are most sensitive to interest cost, such as residential housing, business investment, and durable consumer goods (for example, automobiles and large household appliances). Higher mortgage interest rates depress the demand for housing. Higher corporate bond rates increase the cost of borrowing for businesses and, thus, restrain the demand for additions to plants and equipment; and tighter supplies of bank credit may constrain the demand for investment goods by those firms particularly dependent on bank loans. Furthermore, higher rates on loans for motor vehicles re­duce consumers' demand for cars and light trucks. Beyond these effects, consumption demand is lowered by a reduction in the value of household assets—such as stocks, bonds, and land—that tends to result from higher long-term interest rates.

The implications of changes in interest rates extend beyond do­mestic money and credit markets. Continuing with the example, when interest rates in the United States move higher in relation to those abroad, holding assets denominated in U.S. dollars becomes more appealing, and the demand for dollars in foreign exchange markets increases. A result is upward pressure on the exchange value of the dollar. With flexible exchange rates (rates that fluctu­ate as the supply of and demand for national currencies vary), the dollar strengthens, the cost of imported goods to Americans de­clines, and the price of U.S.-produced goods to people abroad rises. As a consequence, demands for U.S. goods are reduced as Americans are induced to substitute goods from abroad for those produced in the United States and people abroad are induced to buy fewer American goods.

Such changes in the demand for goods and services get translated into changes in total production and prices. Lessened demand re­sulting from higher interest rates and the stronger dollar tends to reduce production and thereby relieve pressures on resources. In an economy that is overheating, this relief will curb inflation. Pro­duction is the first to respond to monetary policy actions; prices and wages respond only later. There is considerable inertia in wages and prices, largely because much of the U.S. economy is characterized by formal and informal contracts that limit changes in prices and wages in the short run and because inflation expec­tations, which influence how people set wages and prices, tend to be slow to adjust. In other words, because many wages and prices do not adjust promptly to a change in aggregate demand, sales and output slow initially in response to a slowing of aggregate de­mand. Over a longer period, however, inflation expectations are tempered, contracts are renegotiated, and other adjustments occur. As a consequence, price and wage levels adjust to the slower rate of expansion of aggregate demand, and the economy gravitates toward full employment of resources.

 

IX. Write a memorandum.

 

The Professor asks the students to write a memo on the content of Monetary and credit aggregates in which they should make up a scheme of what M₁, M₂, M₃ and credit extended to (debt owned by) consist of.

 

The Federal Reserve publishes data on three monetary aggregates. The first, Ml, is made up of types of money commonly used for payment, basically currency and checking deposits. The second, M2, includes Ml plus balances that generally are similar to transaction accounts and that, for the most part, can be converted fairly readily to Ml with little or no loss of principal. The M2 measure is thought to be held primarily by households. The third aggregate, M3, includes M2 plus certain accounts that are held by entities other than individuals and are issued by banks and thrift institutions to augment M2-type balances in meeting credit demands; it also includes balances in money market mutual funds held by institutional investors.

The Federal Reserve publishes a broad measure of credit extended to domestic nonfinancial sectors.

The aggregates have had different roles in monetary policy as their reliability as guides has changed.

 

X. Read the passage below and explain the meanings of the words and phrases which have been highlighted.

 

All of the guides to monetary policy discussed above have some­thing to do with the transmission of monetary policy to the economy. As such, they have certain advantages. However, none has shown a consistently close enough relationship with the ulti­mate goals of monetary policy that it can be relied upon single-mindedly. As a consequence, makers of monetary policy have tended to use a broad range of indicators—those discussed above along with information about the actual performance of output and prices—to judge trends in the economy and to assess the stance of monetary policy.

Such an eclectic approach enables the Federal Reserve to use all available information in conducting policy. This may be especially necessary as market structures and economic processes change in ways that affect the usefulness of any single indicator. However, communicating policy intentions and actions to the public can be more difficult with the eclectic approach than with the approach, for example, of targeting the money stock if the linkage between the money stock and the economy were fairly close and reliable. And, by looking at many variables, which necessarily will give some conflicting signals, the Federal Reserve may delay taking needed action toward restraint or expansion suggested by one or more indicators. As a consequence, more aggressive measures may be needed later if the ultimate goals of policy are to be achieved.

Exchange rate movements are an important channel through which monetary policy affects the economy, and they tend to re­spond promptly to a change in the provision of reserves and in in­terest rates. Information on exchange rates, like that on interest rates, is available almost continuously throughout each day.

Interpreting the meaning of movements in foreign exchange rates, however, is not always straightforward. A decline in the foreign exchange value of the dollar, for example, could indicate that mon­etary policy had become more accommodative, with possible risks of inflation. But foreign exchange rates respond to other influ­ences, such as market assessments of the strength of aggregate de­mand or developments abroad. For example, a weaker dollar on foreign exchange markets could instead suggest lessened demand for U.S. goods and decreased inflationary pressures. Or a weaker dollar could result from higher interest rates abroad—making assets in those countries more attractive—that could come from strengthening economies or the tightening of monetary policy abroad.

Determining which level of the exchange rate is most consistent with the ultimate goals of policy can be difficult. Selecting the wrong level could lead to a sustained period of deflation and high levels of economic slack or to a greatly overheated economy. Also, reacting in an aggressive way to exchange market pressures could result in the transmission to the United States of certain distur­bances from abroad, as the exchange rate could not adjust to cushion them. Consequently, the Federal Reserve does not have specific targets for exchange rates but considers movements in those rates in the context of other available information about financial mar­kets and economies at home and abroad.

 

XI. Analyze the following text. Make up a plan of it; give the translation of the underlined words and word combinations.

 

Open Market Operations

Open market operations involve the buying and selling of securi­ties by the Federal Reserve. A Federal Reserve securities transac­tion changes the volume of reserves in the depository system: A purchase adds to nonborrowed reserves, and a sale reduces them. In contrast, the same transaction between financial institutions, business firms, or individuals simply redistributes reserves within the depository system without changing the aggregate level of reserves.

When the Federal Reserve buys securities from any seller, it pays, in effect, by issuing a check on itself. When the seller deposits the check in its bank account, the bank presents the check to the Fed­eral Reserve for payment. The Federal Reserve, in turn, honors the check by increasing the reserve account of the seller's bank at the Federal Reserve Bank. The reserves of the seller's bank rise with no offsetting decline in reserves elsewhere; consequently, the total volume of reserves increases. Just the opposite occurs when the Federal Reserve sells securities: The payment reduces the re­serve account of the buyer's bank at the Federal Reserve Bank with no offsetting increase in the reserve account of any other bank, and the total reserves of the banking system decline. This characteristic—the dollar-for-dollar change in the reserves of the depository system with a purchase or sale of securities by the Federal Reserve—makes open market operations the most pow­erful, flexible, and precise tool of monetary policy.

In theory, the Federal Reserve could provide or absorb bank re­serves through market transactions in any type of asset. In prac­tice, however, most types of assets cannot be traded readily enough to accommodate open market operations. For open market operations to work effectively, the Federal Reserve must be able to buy and sell quickly, at its own convenience, in whatever volume may be needed to keep the supply of reserves in line with prevailing policy objectives. These conditions require that the instrument it buys or sells be traded in a broad, highly active market that can accommodate the transactions without distortions or disruptions to the market itself.

 

 

 

 

 

 

The market for U.S. government securities satisfies these condi­tions, and the Federal Reserve carries out by far the greatest part of its open market operations in that market. The U.S. govern­ment securities market, in which overall trading averages more than $100 billion a day, is the broadest and most active of U.S. financial markets. Transactions are handled over the counter (that is, not on an organized stock exchange), with the great bulk of orders placed with specialized dealers (both bank and nonbank). Although most dealer firms are York City, a network of telephone and services links dealers and customers regardless of their location to form a worldwide market.

The Federal Reserve's holdings of government securities are tilted somewhat toward Treasury bills, which have maturities of one year or less. The average maturity of the Federal Reserve’s portfolio of Treasury issues is only a little more than 3 years, somewhat below the average maturity of roughly 5¹/₂ years for all outstanding marketable Treasury securities. In the 1980s, the average maturity of the Federal Reserve's portfolio shortened somewhat, as the Federal Reserve began to emphasize liquidity in managing its portfolio. More recently the Federal Reserve has slightly lengthened the average maturity of its portfolio.