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Understanding monetary policy implementation

  • Huberto M. Ennis
  • Todd Keister

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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File URL: http://www.richmondfed.org/publications/research/economic_quarterly/2008/summer/pdf/ennis.pdf
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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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  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. Adam Ashcraft & James McAndrews & David Skeie, 2009. "Precautionary reserves and the interbank market," Staff Reports 370, Federal Reserve Bank of New York.
  3. Marvin Goodfriend, 2002. "Interest on reserves and monetary policy," Economic Policy Review, Federal Reserve Bank of New York, issue May, pages 77-84.
  4. Spence Hilton & Warren B. Hrung, 2007. "Reserve levels and intraday federal funds rate behavior," Staff Reports 284, Federal Reserve Bank of New York.
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  6. Guthrie, Graeme & Wright, Julian, 2000. "Open mouth operations," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 489-516, October.
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  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. Bech, Morten L. & Garratt, Rod, 2003. "The intraday liquidity management game," Journal of Economic Theory, Elsevier, vol. 109(2), pages 198-219, April.
  12. 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.
  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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