Effects of the Federal Reserve’s Monetary Policy

Introduction

Monetary policy is important for any economy. It helps to monitor how the economy is doing and allows a monetary authority to influence the direction that an economy would take. Federal Reserve Monetary Policy has a great influence on the financial institutions and markets. It uses expansionary and contractionary methods. The report will analyze Wells Fargo, the fourth-largest bank in the United States with annual revenues of $103,915 (Macrotrends.net., 2020). The next six months will be predicted to show how Wells Fargo responds to the monetary policy applied by the Federal Reserve.

US Federal Reserve influence on unemployment and inflation

In the short run, monetary policy can influence inflation and the demand for goods and services around the country. In that sense, there will also be a demand for employees who will have to produce the said goods and services. The Federal Reserve undertakes monetary policy by managing short term interest rate levels (Mester, 2018). It further influences the availability of credit and the costs of its acquisition. The monetary policy exerted by the Federal Reserve affects the interest rates directly. The stock prices, wealth and foreign exchange rates are also affected but indirectly. The Federal Reserve adjusts the federal fund rate. The federal fund rates are rates on interests that banks charge on one another for shorter, loans.

The Federal Reserve has to put a check the inflation in the economy. Monetary policy can influence inflations. A lower federal funds rate results in stronger demand for goods and services. The wages and other costs are pushed higher and that reflects a greater demand for workers and materials that will be used for goods and service production. More people will be able to afford the costs of borrowing which will eventually result in inflation. The expansionary market policy is used by the Federal Reserve to reduce the rate of unemployment in the country. The money supply will increase through the lowering of the market interest rates. High-interest rates tend to result in unemployment.

Federal Reserve’s traditional and nontraditional monetary policy tools

This section mainly analyses three traditional monetary policy tools.  These are open market operations, reserve requirements, and discount rates.

Open Market Operations

With this tool, the US Federal Reserve buys or sells securities. These securities are bought from and sold to the private banks. If the Federal Reserve buys securities, the bank that sells the securities adds cash to its reserves (Hubbard & Varma, 2014). It implies that they will have more money at their disposal to lend to the market. If the Federal Reserve sells its securities, the banks will have a reduced cash holding meaning that it will not have much to lend. The Federal Reserve will buy securities if it wants an expansionary monetary policy. It will also sell the securities if it wants to exercise a contractionary monetary policy.

Reserve Requirement

The reserve requirement is the money that a bank is expected to hold on hand overnight. These could be kept at the Federal; Reserve or in their vaults. A low reserve requirement allows the banks to lend more to their customers.  It is expansionary since it avails more credit to the market. A high reserve means that the banks will not lend as much. It is contractionary since little money is available for lending.

Discount Rate

The discount rate is the rate that the Federal Reserve charges its members to borrow during the discount window. It is usually higher than the fed funds rate. Critically, it is not the best option for banks and they would only take it if they cannot borrow from other banks. There is a stigma attached to the discount rate since it is associated with a notion that only banks in trouble use it.

Non-traditional policy tools

Quantitative Easing

The Federal Reserve also engages in large scale asset purchasing called Quantitative Easing. By buying government, agent and mortgage-backed securities; it would reduce the supply of securities available in the market (Feldkircher & Huber, 2018). The prices will be driven up high which in turn pushes down the interest rates on the securities. The people would, therefore, take up long term loans which they would pay with low interest.

Yield Curve

Where the government buys long-term bonds and sells long term debt. It will help in improving the housing markets financed by the long term mortgage debts.

Pros and cons of the FR implementing expansionary or contractionary monetary policy tools

The Federal Reserve uses both contractionary and expansionary monetary policies. But these have their pros and cons. The government can influence the economy by varying the one supply quantity. It is mainly done through the raising or lowering of the market interest rates. Monetary policy is used by a monetary authority on a given country to control the amount of money circulating in the economy. The aim is to stabilize prices and lower unemployment.

The advantage of the expansionary policy

The expansionary monetary policy is used to reduce the rate of unemployment in the country. It is advantageous in that regard. If the interest rates are lowered, it means that the cost of borrowing is cheaper making the money supply increase (Hubbard & Varma, 2014). The increase in money supply stimulates business investments which are further able to create employment opportunities.

The disadvantage of expansionary monetary policy

The monetary policy can harm the economy. As the economy grows with more employment opportunities, price stabilization, etc., it could result eventually in inflation. Inflation would arise as a result of an increase in the money supply in the economy. If further lead s to higher wages and higher costs of production input resulting in cost-push inflation

Advantages of contractionary monetary policy

Contractionary monetary policy is beneficial since it cures inflation problems in an economy. If applied, it reduces the amount of money in circulation and subsequently raises interest rates (Mester, 2018). It also pushes the demand and costs of production to acceptable levels. It, therefore, stabilizes prices.

Disadvantages of contractionary monetary policy

The contractionary monetary policy would be wrongly applied in case of a recession. It would accelerate an economy to fall faster into depressions fr4om a recession. The high-interest rates will leave a small amount of money supplied in the already suppressed economy. Investments would have a hard time bringing return because of slowed production and unemployment would occur.

 

 

Wells Fargo financial situations during the previous five years

Source:(Macrotrends.net., 2020).

The reports chose to evaluate the financial performance of wells Fargo. It is one of the largest financial institutions in the American banking industry. In 4th place, the bank has one of the highest revenues in the market. The table above shows the performance of the banks in terms of annual revenue for the last five years. It demonstrates that the bank has had a steady growth in revenues despite is recent scandals opening new accounts for their existing customers without their knowledge. From ten trends it is expected that the banks will continue to register even higher revenues and profits. The banking industry is strong in the US. It is a determinant of the sound of the US economy. Wells Fargo happens to be a beneficiary of the market. The quarterly revenue, however, shows a small decline in revenues but that was reversed looking at the 2019 annual revenues.

How Wells Fargo has been responding to changes in the Federal Reserve’s monetary policy

Since 2015, the financial regulators in the United States have required that banks hold a certain minimum level of high-quality liquid assets. The bank follows the directive so that it is prevented from running into acute liquidity shortages (Hubbard & Varma, 2014). The liquidity shortage was a recipe for the 2007-20008 financial crises. With such liquidity regulation, Wells Fargo seeks to hold more reserves. It would help it to lend more to the customers.

But the US Federal Reserve reduced the bank reserve amounts so that they could not lend as they wanted. To respond to the declining reserves holdings between 2014 and 2019, the banks adjusted their levels of the reserve to fit within the financial market situation (Balcilar et al., 2020). If the Federal Reserve Bank increases its interest rates, Wells Fargo does not issue out loans to the market. They tend to have little money to issue since it does not have enough. But if the Federal Reserve lowers the interest rates as the case has been recent, Wells Fargo can lend more money and obtain interest income from its loans putting it on the map of the strongest banks in the United States. If the Federal Reserve uses the contractionary policy, the bank is likely to lay off workers because it would no longer have the money to pay them salaries. In that sense, it will maintain profit levels. If the Federal Reserve uses the expansionary policy like it is using now, Wells Fargo will have more to lend and more to hire workers to increase its productivity and subsequently high revenues and profits as displayed in the five-year annual report of revenues.

Explain how the Federal Reserve’s monetary policy affects Wells Fargo

In some cases, the Federal Reserve raises the federal funds rate. Wells Fargo may not respond in a completely competitive way. The bank is more monopolistic since it does not raise the interest rates on savings deposits to its customers by the same amount of rate raised by the Federal Reserve. Usually, banks raise the deposit rates by only 35% to 40% of the rates that are raised by the Federal Reserve (Adrian & Liang, 2016). It implies that depositors are charged a big spread and so that they can make a lot of profits from this. It is clear how profitable the banks have been in the past eleven years that the US economy has been growing. Most people are not sensitive to this spread and that makes it easy for banks to charge it. The few who are sensitive tend to pull out their savings from the banks. When the customers pull their money away from their accounts, the amounts that the banks are left with to lend are shrunk. It means that Wells Fargo, for instance, will contract the amount that it lends to the market and also the number of assets that they purchase.

How the Federal Reserve’s monetary policy will change in the next six months

The Federal Reserve is likely to continue implementing the expansionary policy. At this time in the United States, the rate of unemployment is at its lowest at 3.5% (Mester, 2020). It is expected that the rate grows further down going into 2020. The US economy has continued to grow compared to its main competitors. As expansion monetary policy continues, there will be a solid performance in the labor market. Inflation will be low and stable. The GDP grew by 2.5% in 2018, 2.3% in 2019 and is expected to slow to 2% in 2020 (Lee & Bowdler, 2020). It still represents a growing GDP going into 2020. To this extent, the Federal Reserve will continue with its expansionary policy for a stronger economy.

How the change will affect Wells Fargo and the financial markets

The report predicts that the market will continue with its upsurge trend. The Federal Reserve will continue applying the expansionary monetary policy though not aggressively. It is expected that there will be sufficient supply for the financial market such that the banks will have some reserves to lend to their customers. They will also hire be able to hire more employees thereby ensuring that unemployment is at its lowest in history. Inflation will also be kept at bay. The inflation figures will be low and stable (Mester, 2020). Wells Fargo has another quarter or two of profit-making and more revenues better the tables start turning. The financial markets will remain strong going into the next six months.

How Wells Fargo would respond to the anticipated Federal Reserve’s monetary policy

Wells Fargo will have to respond accordingly to the expansions monetary policy that is expected to going for a while. The interest rates are low. The cost of borrowing is subsequently low (Cecchetti et al., 2020). The banks will be able to issue loans to their customers since they can easily afford to repay. The bank is expected to continue making use of its available resources to improve its profitability even further. The market is a table and no sudden changes are expected at the moment. The Federal Reserve banks are also expected to allow the banks to have more reserves in their treasuries to be available for more lending.

 

Conclusion 

Monetary policy can influence inflations. A lower federal funds rate results in stronger demand for goods and services. The wages and other costs are pushed higher and that reflects a greater demand for workers and materials that will be used for goods and service production. More people will be able to afford the costs of borrowing which will eventually result in inflation. The expansionary market policy is used by the Federal Reserve to reduce the rate of unemployment in the country. The money supply will increase through the lowering of the market interest rates. High-interest rates tend to result in unemployment. If the Federal Reserve lowers the interest rates as has been the case recently, Wells Fargo can lend more money and obtain interest income from its loans putting it on the map of the strongest banks in the United States. If the Federal Reserve uses the contractionary policy, the bank is likely to lay off workers.

 

 

 

References

 

Adrian, T., & Liang, N. (2016). Monetary policy, financial conditions, and financial stability.

 

Balcilar, M., Ozdemir, Z. A., Ozdemir, H., & Wohar, M. E. (2020). Fed’s Unconventional Monetary Policy and Risk Spillover in the US Financial Markets. The Quarterly Review of Economics and Finance.

 

Cecchetti, S. G., Mancini-Griffoli, T., Narita, M., & Sahay, R. (2020). US or Domestic Monetary Policy: Which Matters More for Financial Stability?IMF Economic Review, 1-31.

 

Feldkircher, M., & Huber, F. (2018). Unconventional US monetary policy: new tools, same channels?Journal of Risk and Financial Management, 11(4), 71.

 

Hubbard, R. G., & Varma, S. (2014). Money, banking, and the financial system. Boston: Pearson.

 

Lee, S., & Bowdler, C. (2020). US Monetary Policy and Global Banking Flows. Journal of International Money and Finance, 102118.

 

Macrotrends.net. (2020). Wells Fargo Revenue 2006-2019 | WFC. Macrotrends.net. Retrieved 1 March 2020, from https://www.macrotrends.net/stocks/charts/WFC/wells-fargo/revenue.

 

Mester, L. J. (2018). Issues for US Monetary Policy.

 

Mester, L. J. (2020). The Outlook for the Economy and Monetary Policy in 2020.


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