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Understanding monetary policy implementation

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Author Info

  • Huberto M. Ennis
  • Todd Keister

Abstract

The Federal Reserve implements its monetary policy objectives by intervening in the interbank market for overnight loans. In particular, it aims to change the supply of reserves available to commercial banks so that the (average) interest rate in this market equals an announced target rate. A recent change in legislation will give the Federal Reserve greater flexibility in this process by allowing it to pay interest on reserve balances. Together, the change and recent events in financial markets have renewed interest in the process of monetary policy implementation. This article presents a simple analytical framework for understanding this process. We use the framework to illustrate the main factors that influence a central bank’s ability to keep the market interest rate close to a target level. We also discuss how paying interest on reserves can be a useful policy tool in this regard.

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Bibliographic Info

Article provided by Federal Reserve Bank of Richmond in its journal Economic Quarterly.

Volume (Year): (2008)
Issue (Month): Sum ()
Pages: 235-263

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Handle: RePEc:fip:fedreq:y:2008:i:sum:p:235-263:n:v.94no.3

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Related research

Keywords: Monetary policy ; Federal Reserve banks;

References

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  1. Clouse, James A. & Dow, James Jr., 2002. "A computational model of banks' optimal reserve management policy," Journal of Economic Dynamics and Control, Elsevier, vol. 26(11), pages 1787-1814, September.
  2. Bech, Morten L. & Garratt, Rod, 2001. "The Intraday Liquidity Management Game," University of California at Santa Barbara, Economics Working Paper Series qt0m6035wg, Department of Economics, UC Santa Barbara.
  3. Leonardo Bartolini & Giuseppe Bertola & Alessandro Prati, 2000. "Day-to-day monetary policy and the volatility of the federal funds interest rate," Staff Reports 110, Federal Reserve Bank of New York.
  4. James McAndrews & Samira Rajan, 2000. "The timing and funding of Fedwire funds transfers," Economic Policy Review, Federal Reserve Bank of New York, issue Jul, pages 17-32.
  5. Marvin Goodfriend, 2002. "Interest on reserves and monetary policy," Economic Policy Review, Federal Reserve Bank of New York, issue May, pages 77-84.
  6. Adam Ashcraft & James McAndrews & David Skeie, 2009. "Precautionary reserves and the interbank market," Staff Reports 370, Federal Reserve Bank of New York.
  7. Huberto M. Ennis & John A. Weinberg, 2007. "Interest on reserves and daylight credit," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 111-142.
  8. Peter D. Sternlight, 1964. "Reserve Settlement Periods Of Member Banks: Comment," Journal of Finance, American Finance Association, vol. 19(1), pages 94-98, 03.
  9. Todd Keister & Antoine Martin & James McAndrews, 2008. "Divorcing money from monetary policy," Economic Policy Review, Federal Reserve Bank of New York, issue Sep, pages 41-56.
  10. Spence Hilton & Warren B. Hrung, 2007. "Reserve levels and intraday federal funds rate behavior," Staff Reports 284, Federal Reserve Bank of New York.
  11. Albert H. Cox Jr. & Ralph F. Leach, 1964. "Open Market Operations And Reserve Settlement Periods: A Proposed Experiment," Journal of Finance, American Finance Association, vol. 19(3), pages 534-539, 09.
  12. Guthrie, Graeme & Wright, Julian, 2000. "Open mouth operations," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 489-516, October.
  13. William Poole, 1968. "Commercial Bank Reserve Management In A Stochastic Model: Implications For Monetary Policy," Journal of Finance, American Finance Association, vol. 23(5), pages 769-791, December.
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Citations

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Cited by:
  1. Ricardo Lagos & Gara Afonso, 2010. "Trade Dynamics in the Market for Federal Funds," 2010 Meeting Papers 424, Society for Economic Dynamics.
  2. Afonso, Gara M. & Lagos, Ricardo, 2014. "The over-the-counter theory of the fed funds market: a primer," Staff Reports 660, Federal Reserve Bank of New York.
  3. Bech, Morten L. & Klee, Elizabeth, 2011. "The mechanics of a graceful exit: Interest on reserves and segmentation in the federal funds market," Journal of Monetary Economics, Elsevier, vol. 58(5), pages 415-431.
  4. Todd Keister & Antoine Martin & James McAndrews, 2008. "Divorcing money from monetary policy," Economic Policy Review, Federal Reserve Bank of New York, issue Sep, pages 41-56.
  5. Alejandra Anastasi & Pedro Elosegui & Máximo Sangiácomo, 2010. "Call Money Interest Rate Determinants in Argentina," Ensayos Económicos, Central Bank of Argentina, Economic Research Department, vol. 1(57-58), pages 95-126, January -.
  6. Andreas Hornstein, 2010. "Monetary policy with interest on reserves," Economic Quarterly, Federal Reserve Bank of Richmond, issue 2Q, pages 153-177.
  7. Morten Bech & Todd Keister, 2012. "On the liquidity coverage ratio and monetary policy implementation," BIS Quarterly Review, Bank for International Settlements, December.
  8. Morten L Bech & Cyril Monnet, 2013. "The Impact of Unconventional Monetary Policy on the Overnight Interbank Market," RBA Annual Conference Volume, in: Alexandra Heath & Matthew Lilley & Mark Manning (ed.), Liquidity and Funding Markets Reserve Bank of Australia.
  9. Morten L. Bech & Todd Keister, 2013. "Liquidity regulation and the implementation of monetary policy," BIS Working Papers 432, Bank for International Settlements.
  10. Antoine Martin & James McAndrews & Ali Palida & David Skeie, 2013. "Federal Reserve tools for managing rates and reserves," Staff Reports 642, Federal Reserve Bank of New York.
  11. Antoine Martin & James McAndrews & David Skeie, 2011. "A note on bank lending in times of large bank reserves," Staff Reports 497, Federal Reserve Bank of New York.
  12. Arto Kovanen, 2011. "Monetary Policy Transmission in Ghana," IMF Working Papers 11/275, International Monetary Fund.
  13. Todd Keister & James J. McAndrews, 2009. "Why are banks holding so many excess reserves?," Current Issues in Economics and Finance, Federal Reserve Bank of New York, vol. 15(Dec).
  14. Judson, Ruth A. & Klee, Elizabeth, 2010. "Whither the liquidity effect: The impact of Federal Reserve open market operations in recent years," Journal of Macroeconomics, Elsevier, vol. 32(3), pages 713-731, September.
  15. Judson, Ruth A. & Klee, Elizabeth, 2011. "Big bank, small bank: Monetary policy implementation and banks' reserve management strategies," Journal of Economics and Business, Elsevier, vol. 63(4), pages 306-328, July.

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