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
