CH15

d. FOMC increases the target federal funds rate and NY Fed conducts necessary operations to achieve it.

NY Fed would need to conduct dynamic open market sale to achieve the higher target. In this case the supply of reserves would shift left thereby increasing the market FFR

In the market for reserves, a lower interest rate paid on excess reserves

decreases the effective floor for the federal funds rate.

If the demand for reserves is supposed to increase temporarily, the manager of the trading desk at the Federal Reserve Bank of New York will likely conduct a ________ open market ________

defensive; purchase

Suppose FOMC increased its target federal funds rate. Assuming that demand for reserves has not changed, if the New York Fed wishes to keep the effective federal funds rate close to the target level, then the appropriate action to take is a ________ open market ________, everything else held constant.

dynamic; sale

Fed's supplied so much reserves to the system, usual changes in the supply of reserves no longer affects FFR

- This effectively renders open market operations useless. - How can then Fed normalize its policy and go back to FFR being in the range of 3-4%?

Dynamic open market operations

-Designed to implement changes in monetary policy directive from FOMC -Permanently increase or decrease amount of reserves -Outright purchase or sale of Treasury securities

Lending facilities

-Invoking Section 13(3) of Federal Reserve Act, the Fed can lend to any institution or individual in "unusual and exigent" circumstances. -As a response to financial crisis of 2007 -09, Fed opened various "facilities" through which in lent to different institutions -Commercial Paper Funding Facility (CPFF) -Primary Dealer Credit Facility (PDCF) -Money Market Mutual Fund Liquidity Facility (MMLF) -Paycheck Protection Program Liquidity Facility (PPPLF)

Unconventional policy tools

-Large scale asset purchase program -Lending facilities

• Discount policy, id

-Primary credit, 50 basis points above FFR (currently 0.25%), for healthy banks, overnight -Secondary credit, 50 basis points above primary credit rate (0.75%), banks with serious liquidity problems, can be short-term or longer-term .-Seasonal credit, for tourism dependent banks -Provides upper bound for FFR

Interest on reserve balances, irb

-Provides lower bound for FFR, currently at 0.1% -Currently used as a main tool to change FFR

Objectives of Quantitative Easing

-To unfreeze MBS market -Bring 30- year mortgage and 10-year T note interest rates down .-In general, exert a downward pressure on long-term interest rates.

b. Banks increase demand for reserves. The Fed decides to react to keep the federal funds rate at the target.

Demand curve shifts right. To prevent federal funds rate from increase, the Fed would need to offset by increasing supply of reserves. So it would need to conduct defensive open market purchase. Market federal funds rate would not change.

Financial system stability

Maintain public trust in financial markets and institutions

The opportunity cost of holding excess reserves is the federal funds rate

Minus the interest rate paid on excess reserves

Expansionary monetary policy consists of all of the following EXCEPT

Open market sales

e. Fed decides to lower discount rate below the current equilibrium federal funds rate.

This is going to make discount rate as a ceiling binding and hence lower federal funds rate. Basically, it will shift down the flat portion of supply by a large margin.

a. Banks increase demand for reserves. The Fed decides not to react.

a. Demand curve shifts right, which increases market federal funds rate.

OMC sets a target, usually specified as a range, for FFR at its meetings (8 times a year):

currently 0-0.25% -Effective (market) federal funds rate will generally be different (but close) from the target. -But it is NYFED's job to make sure the market rate stays within the target range.

Everything else held constant, in the market for reserves, when the federal funds rate is 3%, lowering the discount rate from 5% to 4%

has no effect on the federal funds rate

In the market for reserves, if the federal funds rate is between the discount rate and the interest rate paid on excess reserves, an increase in the reserve requirement ________ the demand for reserves, ________ the federal funds rate, everything else held constant

increases; raising

Third round, QE3:

purchase of $40b/month MBS and $45b/month long-term Treasuries ended in 2014 Fed just resumed QE in March of 2020 as a response to Coronavirus slowdown.

Which of the following is a potential operating instrument for the central bank?

short term interest rate or monetary base

The main monetary policy instrument:

target federal funds rate

• Open market operations

the purchase and sale of U.S. government bonds by the Fed

• Non-conventional monetary policy tools:

• Asset purchases or QE • Various lending facilities

1. For the each of the following, use the supply and demand of reserves to make the necessary changes, describe the type of policy that the Fed would need to conduct (if any) and indicate what happens to the market (effective) federal funds rate. Unless specified, you can assume that starting FFR is between its upper and lower bounds with a sufficient distance.

a. Banks increase demand for reserves. The Fed decides not to react. b. Banks increase demand for reserves. The Fed decides to react to keep the federal funds rate at the target. c. The Board of Governors increases reserve requirements and directs NY Fed to offset it with open market operations. d. FOMC increases the target federal funds rate and NY Fed conducts necessary operations to achieve it. e. Fed decides to lower discount rate below the current equilibrium federal funds rate.

Simply increase interest on reserves.

- If banks can earn 3%, for example, just by parking cash, then no one will lend at Federal funds market for less than that. Therefore, FFR must increase to 3%. - Essentially, by increasing the floor the Fed also increases market FFR

Goals of Monetary Policy:

- Low and stable inflation - Maximum employment - Dual mandate

Interest-rate and exchange-rate stability

- Secondary goals - Interest rate volatility implies higher risk-> higher risk premiums - Exchange-rate stability: rarely pursued

• Defensive open market operations

-Designed to counter temporary fluctuations in demand for reserves. -Daily -These are repo or reverse repo agreement that temporary increase or decrease supply of reserves

Conventional policy tools or instruments:

-Open market operations and target federal funds rate • Purchase and sale of T-bills • Discount policy • Reserve requirements (no longer used) UPDATE: Fed just lowered this to zero • Interest on reserve balances

Quantitative Easing (QE)

Purchase of MBS and long-term treasury securities on a massive scale, initially started in 2009.

c. The Board of Governors increases reserve requirements and directs NY Fed to offset it with open market operations.

This would increase demand for reserves. Ordinarily this would increase the federal funds rate. However, if the Fed decided to offset it then it would have to increase the supply of reserves to keep federal funds rate unchanged. So this would have to be dynamic open market purchase. It's dynamic because increase in demand is permanent.

Fed lingo:

monetary tightening vs monetary easing

In the market for reserves, if the federal funds rate is above the interest rate paid on excess reserves and below discount rate, then an open market ________ the supply of reserves, raising the federal funds interest rate, everything else held constant.

sale decreases

The policy directive from the FOMC is carried out by

the account manager at the Federal Reserve Bank of New York

Monetary policy

• Market for federal funds • Supply and Demand • Role a discount rate and interest on reserve balances play • Equilibrium