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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. Alessandro Prati & Giuseppe Bertola & Leonardo Bartolini, 2000. "Day-To-Day Monetary Policy and the Volatility of the Federal Funds Interest Rate," IMF Working Papers 00/206, International Monetary Fund.
  2. Marvin Goodfriend, 2002. "Interest on reserves and monetary policy," Economic Policy Review, Federal Reserve Bank of New York, issue May, pages 77-84.
  3. Spence Hilton & Warren B. Hrung, 2007. "Reserve levels and intraday federal funds rate behavior," Staff Reports 284, Federal Reserve Bank of New York.
  4. 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.
  5. 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.
  6. 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.
  7. Adam Ashcraft & James Mcandrews & David Skeie, 2011. "Precautionary Reserves and the Interbank Market," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 43, pages 311-348, October.
  8. 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.
  9. 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.
  10. 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.
  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. Peter D. Sternlight, 1964. "Reserve Settlement Periods Of Member Banks: Comment," Journal of Finance, American Finance Association, vol. 19(1), pages 94-98, 03.
  13. Guthrie, Graeme & Wright, Julian, 2000. "Open mouth operations," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 489-516, October.
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Cited by:
  1. Arto Kovanen, 2011. "Monetary Policy Transmission in Ghana: Does the Interest Rate Channel Work?," IMF Working Papers 11/275, International Monetary Fund.
  2. Andreas Hornstein, 2010. "Monetary policy with interest on reserves," Economic Quarterly, Federal Reserve Bank of Richmond, issue 2Q, pages 153-177.
  3. 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.
  4. 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.
  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. Morten Bech & Todd Keister, 2012. "On the liquidity coverage ratio and monetary policy implementation," BIS Quarterly Review, Bank for International Settlements, December.

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