The Evolving Structure of the US Federal Market Analysis of Speech by Governor Jerome Powell, Federal Reserve Bank of New York, October 20, 2015

TheEvolving Structure of the US Federal Market: Analysisof Speech by Governor Jerome Powell, Federal Reserve Bank of NewYork, October 20, 2015

XuelianKang

GeorgiaState University

TheEvolving Structure of the US Federal Market: Analysisof Speech by Governor Jerome Powell, Federal Reserve Bank of NewYork, October 20, 2015

WhileOpening a two-day conference bringing together stakeholders in the USfinancial sector to deliberate on the impacts that changes inTreasury markets had on liquidity, the Governor pointed out severalpolicies the Federal bank was contemplating as instruments tostabilize the equilibrium in the financial markets. Quick to pointout the significance of the Treasury markets to the US financialsector and economy in general, the Governor noted that there was anurgent need to ascertain if indeed liquidity was in broad decline andif so, then it was necessary to identify the underlying causes ofthis decline. Moreover, he pointed out that the changes in thetreasury markets had been greatly influenced by technology and newparticipants who had made the market more complex. The tone of theGovernor’s statements cannot be mistaken: it signifies a relentlesseffort to tame the new “game changers” that had madecommunication so fast and compromised the efficacy of financialregulatory instruments. By stressing that the spiral effects of thechanges currently witnessed in the Treasury markets weighed heavilyon liquidity and end users, the policies of the Federal Reserve Bankare likely to tighten the monetary instruments especially thosetargeted at the “receiving end.”

Takentogether, the key statements made by the Governor point to a possiblemonetary policy that would keep the level of liquidity in check. Insuch an attempt, the most likely scenario that the Federal ReserveBank is contemplating is to increase the amount of money supply inthe economy (liquidity) while simultaneously keeping prices constantadjustments of interest rates. Keynesian economics provides a varietyof interpreting the mechanisms of this possibility and more so, thelikely influences of such a policy. Conventionally, when the interestrates are low, the aggregate demand in an economy rises and so doesthe liquidity level. Since the Federal Reserve Bank has a directinfluence on the levels of interest rates, there is the likelihoodthat they will exploit the interest rate-aggregate demand nexus tokeep liquidity in check. Using the IS-LM model provides a clearerpicture of the policy implications since the model can be used toanalyze fluctuations in the economy and to find the most appropriatestabilization policies. The diagram below shows the most likelyoutcomes if the desire of the Federal Reserve Bank wants to increaseliquidity that the Governor notes is on the decline.

Figure1.0:Effects of lowering interest rates on liquidity

Adoptedfrom Topical Economics (2015)

Asshown in the model, if the Federal Reserve Bank sells Treasurysecurities to the public as contemplated by the Governor, there willbe increased money supply in the economy shown by a shift in LM curvefrom LM1to LM2.This will reduce interest rates from i1toi2andraise the national income from Y1toY2,ultimately leading to an increase in prices since an increase innational income is synonymous with an increase in aggregate demand.The model shows that through direct trade in the public market, apossibility emphasized by the Governor, the Federal Reserve Bank islikely to influence the stability of the economy to achieve therequired level of liquidity. The clearest pointer to this approach bythe regulator is the statement made by the Governor to the effectthat they need first to build confidence in the Treasury assets sincethis will stimulate demand for Treasury securities in the Treasuryrepo markets. Nevertheless, there is likely to be a stringent andprudent supervision of commercial banks in the near future. For theanticipated changes in the financial sector and the economy ingeneral, it is important that these impacts are taken into accountwhen making decisions as concerns transfer of assets and financing ofprojects through credit.

1.Identification

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2.Analytic

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Applies economic concepts (and related formulae) correctly to the given questions

Understands and solving the problem

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3.Application and Critical Judgment

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Analyzes ideas and able to interpret the result from analytical solution

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Critical thinking used in clearly stating own opinion and that of others carefully cited.

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4.Communication and Structural organization

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Communication

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Language clearly and effectively communicates ideas.

Organization is clear.

Assignment clearly has introduction, body, discussion, conclusion and reference section, if applicable.

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References

FederalReserve Bank, (2015)., TheEvolving Structure of the US Federal Market:Speech by Governor Jerome Powell, Federal Reserve Bank of New York.Retrieved on November 4, 2015,from&lthttp://www.federalreserve.gov/newsevents/speech/powell20151020a.htm&gt

TopicalEconomics, (2015)., IS-LM Model Explained., Retrieved on November 4,2015 fromhttp://topicalecons.blogspot.co.ke/2013/02/is-lm-model.htm

Brayton,F., Levin, A., Lyon, R., &amp Williams, J. C. (1997, December). Theevolution of macro models at the Federal Reserve Board.In&nbspCarnegie-RochesterConference Series on Public Policy&nbsp(Vol.47, pp. 43-81). North-Holland.

Bartolini,L., Bertola, G., &amp Prati, A. (2001). Banks’ reserve management,transaction costs, and the timing of federal reserveintervention.&nbspJournalof banking &amp finance,&nbsp25(7),1287-1317.

Dennis,R. (2006). The policy preferences of the US Federal Reserve.&nbspJournalof Applied Econometrics,&nbsp21(1),55-77.