Money and Banking article assignment

Student: Tarek Ali

Article title: Yellen Pledges Clear Signals for Rate PoliciesSource: www.dailyfinance.com

Author: MARTIN CRUTSINGER

WASHINGTON -- Federal Reserve Chair Janet Yellen said Friday that the Fed is striving to

clearly communicate its intentions on interest rates in order to minimize surprises that could

disrupt financial markets both in the United States and globally.

She said central bank policymakers understand that moving from a period of very low interest

rates to more normal levels of interest rates will lead to some heightened volatility in financial

markets.

But she says the normalization of rates will be an important sign that economic conditions are

"finally emerging from the shadow of the Great Recession."

Yellen's comments came in a speech in Paris at a conference sponsored by the Bank of France.

The Fed last week ended its bond buying program but its first increase in rates isn't expected

until mid-2015

"As employment, economic activity and inflation rates return to normal, monetary policy will

eventually need to normalize too, although the speed and timing of this normalization will likely

differ across countries based on differences in the pace of recovery in domestic conditions,"

Yellen said.

"For our part, the Federal Reserve will strive to clearly and transparently communicate its

monetary policy strategy in order to minimize the likelihood of surprises that could disrupt

financial markets, both at home and around the world," Yellen said.

She said that among the lessons learned from the crisis is that central banks need to be prepared

to employ all available tools including unconventional policies such as bond buying to support

economic growth and achieve optimal inflation rates.

Last week, the Fed announced the end of its bond buying program, which had been designed to

keep long-term interest rates low, and upgraded its outlook for the U.S. labor market. The

massive bond purchases have pushed the Fed's balance sheet up by more than $3 trillion to

nearly $4.5 trillion.

In a statement after a two-day meeting, the Fed reiterated its plan to maintain its benchmark

short-term interest rate near zero "for a considerable time." The Fed statement noted that the job

market is strengthening. The statement dropped a previous reference to "significant

underutilization" of available workers.

On Friday, the government reported that the unemployment rate dropped to 5.8 percent in

October as the economy added another 214,000 jobs.

Summary:

The article gives us one of the monetary policies that most central banks such as the Federal

Reserve Bank have which is determining the interest rate in the financial market.

The central banks have mainly six policies which are increasing economic growth, stabilizing

prices, setting and stabilizing the interest rate, supervising financial institutions, stabilize the

foreign exchange market, and achieving high employment.

The Federal Reserve System was created in 1913 to lessen the frequency of bank panics. The

structure consists of twelve regional Federal Reserve banks, around 2900 member commercial

banks, the board of governors of the Federal Reserve System, the federal open market, and the

federal advisory council.

The Federal Reserve System is more independent than other agencies in the US however it is not

the most independent central bank in the world and it is restricted by the legislative power of the

congress.

The central banks have other policies and tools such as too big to fail policy where they save

large banks from going bankrupt by buying shares in the bank or selling it to other banks. In this

way they save the country from a financial panic and save the economic system from a financial

crisis. However this policy recently is banned by many central banks because they are

encouraging large bank to undergo riskier investments given the fact that the central bank will

save them in case of bankruptcy. Too big to fail policy increases moral hazards and adverse

selection and that is why it’s banned.

Central banks monitor the financial system in all and play a major leader in the success or failure

of the financial system. If the central bank is functioning properly then it will help in making the

financial system healthy and vise versa.

Most central banks acquire a required reserve ratio from all deposits in commercial banks to

monitor the financial institutions and to monitor the money supply in the market which is a major

concern for central banks.

The Fed can't control inflation or influence output and employment directly. Instead, it affects

them indirectly by using the following three tools of monetary policy: open market operations,

required reserve ratio, and discount rates.

Example from www.investopedia.com

“An open market purchase increases the reserve supply, causing the federal funds rate to fall. A

higher discount rate - the interest rate that an eligible depository institution is charged to borrow

short-term funds directly from the central bank - will discourage banks from borrowing from the

central bank, decreasing the reserve supply and causing the federal funds rate to rise. Lower

reserve requirements decrease the demand for reserves and can cause the federal funds rate to

fall. A change in the federal funds rate, according to the Federal Reserve, "triggers a chain of

events that affect other short-term interest rates, foreign exchange rates, long-term interest rates,

the amount of money and credit, and, ultimately, a range of economic variables including

employment, output and prices of goods and services.”

In the article it says that the federal system is employing unconventional monetary policies such

as bond buying program to save the financial system from crisis and it has shown that the

unemployment rate decreased after this policy.