Mishkin CH 15

Tools of Monetary Policy
• Open market operations

Affect the quantity of reserves and the monetary base
• Changes in borrowed reserves

Affect the monetary base
• Changes in reserve requirements

Affect the money multiplier
• Federal funds rate—the interest rate on overnight

loans of reserves from one bank to another
Primary indicator of the stance of monetary policy
Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 15-1

Demand in the Market for Reserves
• What happens to the quantity of reserves demanded,

holding everything else constant, as the federal funds
rate changes?
• Two components: required reserves and
excess reserves
Excess reserves are insurance against deposit outflows
The cost of holding these is the interest rate that could have
been earned
• As the federal funds rate decreases, the opportunity
cost of holding excess reserves falls and the quantity
of reserves demanded rises
• Downward sloping demand curve
Supply in the Market for Reserves
• Two components: non-borrowed and

borrowed reserves
• Cost of borrowing from the Fed is the discount rate
• Borrowing from the Fed is a substitute for borrowing
from other banks
• If iff < id, then banks will not borrow from the Fed and
borrowed reserves are zero
• The supply curve will be vertical
• As iff rises above id, banks will borrow more and more
at id, and re-lend at iff
• The supply curve is horizontal (perfectly elastic) at id
Affecting the Federal Funds Rate
• An open market purchase causes the

federal funds rate to fall; an open market
sale causes the federal funds rate to
riseÄ shifting the supply curve
• If the intersection of supply and demand
occurs on the vertical section of the
supply curve, a change in the discount
rate will have no effect on the federal
funds rate

Affecting
the Federal Funds Rate (cont’d)
• If the intersection of supply and demand
occurs on the horizontal section of the supply
curve, a change in the discount rate shifts that
portion of the supply curve and the federal
funds rate may either rise or fall depending on
the change in the discount rate
• When the Fed raises reserve requirement, the
federal funds rate rises and when the Fed
decreases reserve requirement, the federal
funds rate fallsÄ shifting the demand curve

Open Market Operations
• Dynamic open market operations

• Defensive open market operations
• Primary dealers
• TRAPS (Trading Room Automated
Processing System)
• Repurchase agreements
• Matched sale-purchase agreements
Advantages of
Open Market Operations
• The Fed has complete control over

the volume
• Flexible and precise
• Easily reversed
• Quickly implemented

Discount Policy
• Discount window
• Primary credit—standing lending facility
• Secondary credit
• Seasonal credit
• Lender of last resort to prevent
financial panics
Creates moral hazard problem

Advantages and
Disadvantages of Discount Policy
• Used to perform role of lender of

last resort
• Cannot be controlled by the Fed; the
decision maker is the bank
• Discount facility is used as a backup
facility to prevent the federal funds rate
from rising too far above the target

Reserve Requirements
• Depository Institutions Deregulation and

Monetary Control Act of 1980 sets the
reserve requirement the same for all
depository institutions
• 3% of the first $48.3 million of checkable
deposits; 10% of checkable deposits over
$48.3 million
• The Fed can vary the 10% requirement
between 8% to 14%

Disadvantages
of Reserve Requirements
• No longer binding for most banks

• Can cause liquidity problems
• Increases uncertainty
• Recommendations to eliminate

The Channel/Corridor System
• Sets up a standing lending facility (lombard

facility) and stands ready to loan overnight any
amount banks ask for at a fixed interest rate
(lombard rate)
• The supply of reserves is infinitely elastic at
this interest rate
• Another standing facility is set up that pays
banks a fixed interest rate on any deposits
they would like to keep at the central bank

The Channel/Corridor System (cont’d)
• The supply of reserves is also infinitely

elastic at this interest rate
• In between these two interest rates
the quantity supplied is equal to the
non-borrowed reserves
• The demand curve has its usual
downward slope

Monetary Policy Tools
of the European Central Bank
• Open market operations

Main refinancing operations
• Weekly reverse transactions
Longer-term refinancing operations
• Lending to banks
Marginal lending facility/marginal
lending rate
Deposit facility
Monetary Policy Tools
of the European Central Bank (cont’d)
• Reserve Requirements
2% of the total amount of checking deposits and
other short-term deposits
Pays interest on those deposits so cost of
complying is low

Mishkin CH 15

Uploaded by

Copyright:

Available Formats

Mishkin CH 15

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Mishkin CH 15

Uploaded by

Copyright:

Available Formats

Tools of Monetary Policy

• Open market operations

• Changes in borrowed reserves

• Changes in reserve requirements

• Federal funds rate—the interest rate on overnight

Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 15-1

• What happens to the quantity of reserves demanded,

• Two components: non-borrowed and

• An open market purchase causes the

Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 15-5

Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 15-6

• Dynamic open market operations

• The Fed has complete control over

Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 15-11

Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 15-12

• Used to perform role of lender of

Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 15-14

• Depository Institutions Deregulation and

Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 15-15

• No longer binding for most banks

Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 15-16

• Sets up a standing lending facility (lombard

Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 15-17

• The supply of reserves is also infinitely

Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 15-18

• Open market operations

Copyright © 2007 Pearson Addison-Wesley. All rights reserved. 15-21

You might also like