1. Copyright © 2002 Pearson Education, Inc. Open Market Operations Fed purchases and sales of Treasury securities FOMC guides open market ops. Open market purchases are expansionary. Open market sales are contractionary. B uy E ase S ell T ighten Dynamic transactions -- intended to change policy. Outright purchases and sales of Treasury securities Defensive transactions -- offset fluctuations in M-base Repurchase agreements: Fed buys now from dealers Matched sale-purchase agreements: Fed sells now to dealers

2. Copyright © 2002 Pearson Education, Inc. Discount Policy Fed influences volume of discount loans via Price (discount rate) … typically below fed funds rate Terms: Discourages banks from using discount loans. Types of Discount Loans Adjustment credit …meet short term reserve reqs Seasonal credit Extended credit … lender of last resort Discount rate changes have announcement effect Confirm policy direction

3. Copyright © 2002 Pearson Education, Inc. Slide 20-3 Figure 20.1 Discount Rate and Federal Funds Rate, 1970-2000

4. Copyright © 2002 Pearson Education, Inc. Reserve Requirements Reserve requirements: banks must hold part of their deposits in cash or Fed deposits. Fed rarely changes reserve requirements. Every two weeks, the Fed monitors compliance with its reserve requirements. Thursday – Wednesday reserve maintenance period Federal Funds Market: Intrabank Market for Reserves Banks’ demand for federal funds increases as the federal funds rate declines. The supply of reserves is the supply by the Fed of borrowed and nonborrowed reserves.

5. Copyright © 2002 Pearson Education, Inc. Slide 20-5 Figure 20.2 Equilibrium in the Federal Funds Market

6. Copyright © 2002 Pearson Education, Inc. Effects of Changes in Policy An open market purchase decreases the equilibrium federal funds rate. An increase in the discount rate increases the equilibrium federal funds rate. An increase in reserve requirements increases the equilibrium federal funds rate.

7. Copyright © 2002 Pearson Education, Inc. Slide 20-7 Figure 20.3 Effects of Open Market Operations

8. Copyright © 2002 Pearson Education, Inc. Slide 20-8 Figure 20.4 Effects of Changes in the Discount Rate

9. Copyright © 2002 Pearson Education, Inc. Slide 20-9 Figure 20.5 Effects of Changes in Required Reserves