CH 17
 The
most important monetary policy tool.
 The primary determinants of changes in
interest rate and the MB.
 OMO expand reserves and the MB, thus
raising MS and lowering short-term interest
rate.
 Open market sale lower reserves and MB,
lowering MS and raising interest rate.
 Dynamic
OMO: intended to change the
level of reserves and the MB.
 Defensive
OMO: intended to offset
movements in other factors that affect
reserves and the MB (i.e. changes in
treasury deposits).
 Advantages
of OMOs:
 The Fed has complete control over the size
of the operations.
 OMOs are flexible and exact, and can be
used to any extent (small or large).
 OMOs are easily reversed when a mistake is
made.
 Quick effect.
 Made
at the discount window, and used to
influence reserves, MB, and MS:
 Primary
credit: is the discount lending that
plays the most important role in monetary
policy (good credit banks are allowed to
borrow all they want from the primary
credit). Interest rate charged is the
discount rate.
 Secondary
credit: is given to banks that are
in a financial trouble and with sever
liquidity problems(0.5% above discount
rate)
 Seasonal
credit: is given to meet the needs
of a limited number of small banks that
have s seasonal patterns of deposits. The
interest rate charged is linked to federal
funds rate.
 Discount
loans are also important in
preventing financial panics. The Fed is the
“Lender of Last Resort”;
 To
prevent bank failures from spinning out
of control.
 The
Fed provide reserves to banks where
no others would do.
 Discount
policy can be used to signal the
Fed’s intentions about future monetary
policy.
 If
the Fed decided to slow the expansion of
the economy, can “announce” that the
discount rate will increase = the public will
expect the monetary policy to be less
expansionary in the future.
 Advantages
and disadvantages of discount
policy:
 Lender
of last resort, but even if discount
rate is changed, no guarantee that banks
will follow.
 Changes
in (r) affect MS through (m). A rise
in (r) reduces the amount of deposits that
can be supported by a given level of the
MB, leading MS to fall.
A
rise in (r) will also increase the demand
for reserves and raises the federal funds
rate.
 Advantages
 Equal
and disadvantages:
affect of all banks, but can cause
immediate liquidity problems for banks
with low (ER).
 However, this tool is infrequently used.