Chapter 17. Tools of Monetary Policy The market for reserves Open market operations Discount lending Reserve requirements The market for reserves Open market operations Discount lending Reserve requirements

I. The Market for Reserves interbank lending market  federal funds rate FOMC impacts this market  which impacts other debt markets & economy interbank lending market  federal funds rate FOMC impacts this market  which impacts other debt markets & economy

demand for reserves  downward sloping  FF rate is opportunity cost, for bank, of holding reserves supply of reserves  upward sloping  banks will to lend more reserves as FF rate rises demand for reserves  downward sloping  FF rate is opportunity cost, for bank, of holding reserves supply of reserves  upward sloping  banks will to lend more reserves as FF rate rises

The Fed and the FF rate open market operations  shift the supply of reserves discount loans  setting discount rate affects bank borrowing and supply of reserves reserve requirement  affects demand for reserves open market operations  shift the supply of reserves discount loans  setting discount rate affects bank borrowing and supply of reserves reserve requirement  affects demand for reserves

II. Open Market Operations (OMO) buying & selling Treasuries  large & liquid market open market purchase  increase supply of reserves  decrease FF rate OMO are the Fed’s main policy tool buying & selling Treasuries  large & liquid market open market purchase  increase supply of reserves  decrease FF rate OMO are the Fed’s main policy tool

FOMC votes on OMO  votes on FF rate target FRBNY actually buys and sells Treasuries  to achieve the FF rate target FOMC votes on OMO  votes on FF rate target FRBNY actually buys and sells Treasuries  to achieve the FF rate target

FRBNY and OMO in morning determine what type/how much OMO are needed get price quotes from dealers trades executed throughout day in morning determine what type/how much OMO are needed get price quotes from dealers trades executed throughout day

2 types OMO defensive OMO  counteract other factors affecting bank reserves dynamic OMO  change level of reserves defensive OMO  counteract other factors affecting bank reserves dynamic OMO  change level of reserves

temporary changes repurchase agreement (repo)  Fed buys securities, but sells back in a few days  temporary increase in reserves, decrease in FF rate repurchase agreement (repo)  Fed buys securities, but sells back in a few days  temporary increase in reserves, decrease in FF rate

reverse repo  Fed sells securities, buys back w/in a few days  temporary increase in FF rate reverse repo  Fed sells securities, buys back w/in a few days  temporary increase in FF rate

advantages of OMO Fed has complete control OMO are flexible  buy/sell a little or a lot OMO are easily reversible  sell too much? then buy some back OMO quickly impact reserves, FF rate Fed has complete control OMO are flexible  buy/sell a little or a lot OMO are easily reversible  sell too much? then buy some back OMO quickly impact reserves, FF rate

III. Discount Lending each district bank has a discount window  set discount rate  set discount policy lower discount rate  increase borrowing, reserves  decrease FF rate each district bank has a discount window  set discount rate  set discount policy lower discount rate  increase borrowing, reserves  decrease FF rate

why do banks get discount loans?  short-term liquidity problem  serious problems  seasonal reserve fluctuations  but should not ask for help too often why do banks get discount loans?  short-term liquidity problem  serious problems  seasonal reserve fluctuations  but should not ask for help too often

Lender of last resort discount loans are tool for stability of banking system supplements role of FDIC discount loans are tool for stability of banking system supplements role of FDIC

Discount loans & monetary policy discount loans not a good tool not completely under Fed control  banks decide to borrow can give misleading signals  if done for non-policy reasons not easily reversible  cannot change rates on old loans discount loans not a good tool not completely under Fed control  banks decide to borrow can give misleading signals  if done for non-policy reasons not easily reversible  cannot change rates on old loans

IV. Reserve requirement set by the Board of Governors higher requirement  increase demand for reserves  increase FF rate today (since 1992)  3% on checking up to $44.3 million  10% above $44.3 million set by the Board of Governors higher requirement  increase demand for reserves  increase FF rate today (since 1992)  3% on checking up to $44.3 million  10% above $44.3 million

reserve requirement is very powerful tool  too powerful  not good for small adjustments  expensive to change reserve requirement is very powerful tool  too powerful  not good for small adjustments  expensive to change

looking ahead…. how does the Fed move from tools to economic goals? history of monetary policy how does the Fed move from tools to economic goals? history of monetary policy