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Monetary policy under a corridor operating framework


  • George A. Kahn


The Federal Reserve aggressively eased monetary policy during the 2008-09 global financial crisis. The Federal Open Market Committee (FOMC) cut the federal funds rate target to near zero, and the Board of Governors introduced a number of novel liquidity facilities. In addition, the FOMC purchased long-term Treasuries and agency mortgage-backed securities on a large scale. These actions caused the Fed?s balance sheet to balloon. ; As the balance sheet grew to unprecedented size, the Open Market Desk at the New York Fed found it increasingly difficult to achieve FOMC?s target funds rate. In response, in October 2008, as authorized under the Financial Services Regulatory Act of 2006 and the Emergency Economic Stabilization Act of 2008, the Federal Reserve began paying interest on excess reserves. This interest rate expected to establish a floor under the federal funds rate. The discount rate?which since January 2003 has been set as a penalty rate the funds rate target?was expected to limit upward pressure on the funds rate ; With these moves, the Federal Reserve?s operating framework now incorporates the essential elements of a ?channel? or ?corridor? system. In such a system, the target for the federal funds rate would typically be set within the corridor established by the discount rate at the ceiling and interest rate on excess reserves at the floor. Although the Federal Reserve has not formally adopted a channel system, establishing a under the federal funds rate target will be especially important as the Federal Reserve begins to exit its highly accommodative policy stance. ; Kahn examines how a corridor system works in theory and practice. While such a framework may offer a number of advantages as an operating system, it may also create new challenges. The key advantages are that it could help the Federal Reserve achieve its target for the federal funds rate while allowing the balance sheet to act as an independent tool of policy. A key question is whether the discount rate will be an effective ceiling and the interest rate on excess reserves an effective floor. In addition, how changes in the funds rate target, the discount rate and the rate on excess reserves will be sequenced is unclear. In particular, the roles of the FOMC, Board of Governors, and Reserve Bank Boards of Directors in such a system may need to be clarified.

Suggested Citation

  • George A. Kahn, 2010. "Monetary policy under a corridor operating framework," Economic Review, Federal Reserve Bank of Kansas City, vol. 95(Q IV), pages 5-34.
  • Handle: RePEc:fip:fedker:y:2010:i:qiv:p:5-34:n:v.95no.4

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    References listed on IDEAS

    1. Berentsen, Aleksander & Monnet, Cyril, 2008. "Monetary policy in a channel system," Journal of Monetary Economics, Elsevier, vol. 55(6), pages 1067-1080, September.
    2. 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.
    3. Todd Keister & Antoine Martin & James J. McAndrews, 2008. "Divorcing money from monetary policy," Economic Policy Review, Federal Reserve Bank of New York, vol. 14(Sep), pages 41-56.
    4. David Bowman & Etienne Gagnon & Michael P. Leahy, 2010. "Interest on excess reserves as a monetary policy instrument: the experience of foreign central banks," International Finance Discussion Papers 996, Board of Governors of the Federal Reserve System (U.S.), revised 2010.
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    Blog mentions

    As found by, the blog aggregator for Economics research:
    1. How the Fed will tighten
      by Steve Cecchetti and Kim Schoenholtz in Money, Banking and Financial Markets on 2015-08-10 16:53:34


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    Cited by:

    1. Armantier, Olivier & Ghysels, Eric & Sarkar, Asani & Shrader, Jeffrey, 2015. "Discount window stigma during the 2007–2008 financial crisis," Journal of Financial Economics, Elsevier, vol. 118(2), pages 317-335.
    2. Joseph E. Gagnon & Brian Sack, 2014. "Monetary Policy with Abundant Liquidity: A New Operating Framework for the Fed," Policy Briefs PB14-4, Peterson Institute for International Economics.
    3. Green, Christopher & Bai, Ye & Murinde, Victor & Ngoka, Kethi & Maana, Isaya & Tiriongo, Samuel, 2016. "Overnight interbank markets and the determination of the interbank rate: A selective survey," International Review of Financial Analysis, Elsevier, vol. 44(C), pages 149-161.
    4. Michelle L. Barnes, . "Let's talk about it: what policy tools should the Fed \\"normally\\" use?," Current Policy Perspectives, Federal Reserve Bank of Boston.
    5. Joshua Frost & Lorie Logan & Antoine Martin & Patrick E. McCabe & Fabio M. Natalucci & Julie Remache, 2015. "Overnight RRP operations as a monetary policy tool: some design considerations," Staff Reports 712, Federal Reserve Bank of New York.
    6. Drobyshevsky, Sergey M. (Дробышевский, Сергей) & Kiyutsevskaya, Anna M. (Киюцевская, Анна) & Trunin, Pavel V. (Трунин, Павел), 2018. "Scope of Interest Rate Policy of Central Banks
      [Возможности Процентной Политики Центральных Банков]
      ," Economic Policy, Russian Presidential Academy of National Economy and Public Administration, vol. 4, pages 42-61, August.
    7. Blasques, Francisco & Bräuning, Falk & Lelyveld, Iman van, 2018. "A dynamic network model of the unsecured interbank lending market," Journal of Economic Dynamics and Control, Elsevier, vol. 90(C), pages 310-342.
    8. Eric Tymoigne, 2014. "Modern Money Theory, and Interrelations Between the Treasury and Central Bank: The Case of the United States," Journal of Economic Issues, Taylor & Francis Journals, vol. 48(3), pages 641-662.
    9. Dawid Johannes van Lill, 2017. "Changes in the Liquidity Effect Over Time: Evidence from Four Monetary Policy Regimes," Working Papers 704, Economic Research Southern Africa.
    10. Jaremski, Matthew & Mathy, Gabriel, 2018. "How was the quantitative easing program of the 1930s Unwound?," Explorations in Economic History, Elsevier, vol. 69(C), pages 27-49.
    11. repec:agr:journl:v:4(605):y:2015:i:4(605):p:133-144 is not listed on IDEAS
    12. repec:agr:journl:v:4(605):y:2015:i:4(605):p:135-146 is not listed on IDEAS
    13. Renne, Jean-Paul, 2016. "A tractable interest rate model with explicit monetary policy rates," European Journal of Operational Research, Elsevier, vol. 251(3), pages 873-887.
    14. Renne Jean-Paul, 2017. "A model of the euro-area yield curve with discrete policy rates," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 21(1), pages 99-116, February.
    15. Umit BULUT, 2015. "The Interest Rate Corridor as a Macroprudential Tool to Mitigate Rapid Growth in Credits: Evidence from Turkey," Theoretical and Applied Economics, Asociatia Generala a Economistilor din Romania - AGER, vol. 0(4(605), W), pages 133-144, Winter.
    16. Asif Mahmood, 2016. "Transmission of Volatility of Money Market Overnight Repo Rate along the Yield Curve in Pakistan," SBP Research Bulletin, State Bank of Pakistan, Research Department, vol. 12, pages 1-18.
    17. Hanes, Christopher, 2019. "Explaining the appearance of open-mouth operations in the 1990s U.S," The North American Journal of Economics and Finance, Elsevier, vol. 48(C), pages 682-701.
    18. Yuyan Tan & Yang Ji & Yiping Huang, 2016. "Completing China's Interest Rate Liberalization," China & World Economy, Institute of World Economics and Politics, Chinese Academy of Social Sciences, vol. 24(2), pages 1-22, March.

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