ECON 3229 - Chapter 18: Monetary Policy

Intermediate Targets

Monetary Aggregates (M1, M2) Interest rates (short-term and long term)

Suppose NY Fed staff anticipates decrease in demand for reserves. To keep the market FFR close to the target they would need to conduct

defensive open market sale

dynamic open market operations

designed to implement changes in monetary policy directive from FOMC outright purchase or sale of treasury securities

Suppose FOMC updates the target federal funds rate upward. To keep the market FFR close to the new target, NY Fed would need to conduct

dynamic open market sale

Open market purchase by Fed will shift

supply of reserves right

In order to ensure that the target federal funds rate is met:

the Fed uses open market operations to change supply of reserves to meet the demand for reserves at the target rate

Goals of Monetary Policy

1. price stability 2. high employment 3. stability of financial markets and institutions 4. economic growth 5. Interest rate stability 6. Foreign Exchange Market Stability

Non-conventional monetary policy tools

Asset purchases or QE Liquidity provision Commitment to future interest rates (forward guidance)

Interest on reserve balances

By raising the interest rate it pays, the Fed can increase banks' holdings of reserves, potentially increasing the money supply. By reducing the interest rate, the Fed can have the opposite effect.

Defensive Open Market Operations

Designed to counter temporary fluctuations in demand for reserves Daily These are self-reversing purchasing or sales of treasuries

Liquidity provision in 2007-2009

Extended lending to non-banks and non-financial institutions while lowering standards for collateral. Ex: Primary Dealer Credit Facility, closed

Main monetary policy instrument or operational target

Federal funds market and federal funds rate

Which tool of the central bank can be used as an effective "exit strategy"

Interest rate on reserves

Interest on reserve balances

Provides lower bound for FFR, currently at 1.0%

Suppose current discount rate is 2.25%, interest on reserves is 0.25% and effective FFR is 1.75. What effect will lowering discount rate to 1.5% have?

decrease FFR

Suppose current discount rate is 2.25%, interest on reserves is 0.25% and effective FFR is 1.30%. What effect will lowering discount rate to 1.5% have?

no effect on FFR

Tools of the Central Bank

open market operations discount policy reserve requirements interest on reserves (large-scale asset purchases, forward guidance)

Reserve Requirements

regulations on the minimum amount of reserves that banks must hold against deposits

Policy Instruments

reserve aggregates interest rates (short-term such as federal funds rate)

Discount Policy

the policy tool of setting the discount rate and the terms of discount lending

Open Market Operations

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