Please Help Me I Don’t Get It??
Published on Wednesday, February 24, 2010 
- Author
- Posted by admin at 6:53 PM UTC
- Category
- Filed under Uncategorized
- Keywords
- Tagged with Dont, Help, Please
The Federal Reserve has traditionally conducted open market operations through the purchase and sale of government bonds. In principle, could the Federal Reserve conduct monetary policy through the purchase and sale of stocks on the New York Stock Exchange? Do you see any possible drawbacks to such a policy? When the Federal Reserve uses its special powers to buy and sell government bonds, how does buying and selling government bonds affect the supply of money in the economy?
2 Comments
Comment by angel_bu
Based on the managerial economic published by McGraw Hill, the Fed can purchase n sale the stocks in order to control the money supply of the country. by buying the stocks it will increase the money supply in the country and vice versa. the drawback is that the amount of money supply provided will create inflation or deflation since there are flow of money in the economy.
Comment by Chuck B
It’s simple if you understand the flow. When the US government needs money to buy things like missiles, they need to collect taxes. If they don’t have enough tax money to buy that missile, they need to borrow and they do it through the US Treasury who issues a treasury note. It’s exactly like any other loan or bond. The US Treasury is not the same thing as the Federal Reserve however.
The US Treasury basically sells the bond to the Fed who turns around and sells it to other people who want a “risk-free” return. It’s not really risk-free but for the purposes of an intro econ class, you can consider it to be risk-free since the US will not default. The Fed receives the bond and deposits money in the Treasury’s bank account so that it can buy that missile. After it buys the missile from Lockheed, Lockheed now has some money in their bank account that they use to pay employees who now take that money out of the ATM or just leave it in electronic format. By buying that bond from the treasury, the Fed has just added money to the system. Now, say it turns around and sells that treasury to someone else, say China. China has all these dollars sitting around and they can’t really figure out how to spend it all since we won’t let them buy cool stuff like F-15 fighter jets or nuclear power plants. China got those dollars from US citizens who buy chinese goods. So China has all these dollars and can’t figure out how to spend it so they decide the best thing to do is to buy treasuries to collect interest on those dollars. By buying the treasuries from the Fed, they are giving up dollars so those dollars now go out of circulation.
Now, imagine instead of treasuries, the Fed uses stocks on the NYSE. The first problem is that not everyone may agree on the fair price for those stocks and the price may fluctuate making it hard to control the money supply. Another is that we may not allow a foreign government to buy certain stocks. Imagine what would happen if the Fed expanded money supply by buying a ton of Boeing and then needed to contract the supply by selling the stock and China bought up all the shares of Boeing. Imagine if the Fed had bought Enron stock and one day POOF, it becomes worthless. Basically, every US citizen has just lost money on a trade. And also think about what it means if the US government is the major shareholder in a private company. Do you really want the Federal Government to own a controlling share of Paramount or The New York Times?