Chapter 18 The Tools of Federal Reserve Policy
The Federal Reserve Goals and Tools
Goal (Ultimate Objectives)
1. influence greater output
2. lower the unemployment rate
3. prices level stability
Intermediate target variables
1. shot-term interest rates
2. monetary requirement policy
3 Tools of monetary policy or instruments of monetary policy
1. open market operations
2. discount window policy
3. reserve requirement policy
1.Open Market Operations
Bbuying and selling of securities in the open market
The Fed is empowered to buy or sell
1. U.S. Treasury securities
2. federal agency securities
3. bankers acceptances
4. other securities
Domain of the Fed’s Open Market “Activity”
Federal Reserve’s open market operations could be carried out in
any asset. To avoid favoritism, politics, and unintentional signals, the
Fed only buys U.S. government and agency securities and banker’s
acceptances.
When the Fed buys Treasury bonds and bills from public, reserves
and the monetary base expand dollar-for-dollar, and the money supply is
directly increased
When the Fed buys Treasury bonds and bills from banks, reserves
and the monetary base expand dollar-for-dollar, but the money supply is
not directly or immediately affected. This happens when banks initiate the
multiple deposit-expansion process by making loans and buying securities.
The “Effectiveness” Of Open Market Operations
1. Impact on Monetary Variable
Bank Reserves
Monetary Base
Monetary Aggregates
2. Impact on
Security Prices
Interest Rates (Yields)
Fed “buys=purchases” securities
Prices Yields
Spill over to other markets
Bank lending rates
Borrowing, Spending
“Advantages” of Open Market Operations
Precision
firm and accurate control over aggregate bank reserves and the
monetary base
Flexibility
in the market each day, buying & selling large quantities of
securities very easy for the Fed to alter course, reserves the policy
Source of Initiative
The Fed is able to dominate aggregate bank reserves & monetary
base. Depends solely on the Fed.
Early “Disadvantages” of Open Market
Signaling
Changes in the discount rate and reserve requirements are superior
to open market operation in signaling policy changes to the public.
Regional Bias
Prior to well-developed financial markets ,a regional bias
operated in open market operations, because the effects were concentrated
in select urban areas where security dealers were located; open market
operations did not disperse across the nation.
Open Market Operations “& the Federal Funds Rate”
The effects of the Fed’s open market operations transmit very quickly
throughout the nation through the federal funds market
The supply of reserves is determined by Federal Reserve policy.
When the Fed purchases securities, bank reserves are
boosted dollar-for-dollar.
When the Fed sells securities, bank reserves decline dollarfor-dollar.
“Technical Aspects” Of Open Market Operations
1. “Defensive” open market operations (การซื้อขายในเชิงรับ)
Open market operations made for the purpose of “defending” bank
reserves & the monetary base against the influence of outside forces
“Repurchase agreements”(& reserve repurchase agreements)
One party sells securities with an agreement to buy them back at a
specified future
The Fed uses repurchase agreement (repos) and reverse repurchase
agreements to neutralize the impact on reserves and the monetary base
of transitory changes.
2. “Dynamic” open market operations
Open market operations made to deliberately changes the course of
economic activity
To achieve goals (control unemployment, inflation, other economic
variables)
Outright transactions
The Fed uses outright purchases to bring about long-run or
permanent growth in reserves and the monetary aggregates.
2. Discount Window Policy
The fed lends to depository institutions
3 Classes of Credits
Primary credit @ Discount rate
Discount rate = Fed fund rate + 1%
Purpose : to impose an upper limit on the Fed fund rate
Secondary credit
Borrowing Rate = Discount rate + 0.5%
who have liquidity problem
Seasonal credit
Purpose : to banks having seasonal fluctuations in loan demand
3. Reserve Requirement Instrument
Fed has authority to change the rr
Serves as a “Tax” on Deposit Institutions, DIs have to hold
minimum reserves
 Limitation on making loans, buying securities
 Loss opportunity to earn more interest income from making
loans
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