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Understanding monetary policy implementation

Author

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  • 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.

Suggested Citation

  • Huberto M. Ennis & Todd Keister, 2008. "Understanding monetary policy implementation," Economic Quarterly, Federal Reserve Bank of Richmond, vol. 94(Sum), pages 235-263.
    • Handle: RePEc:fip:fedreq:y:2008:i:sum:p:235-263:n:v.94no.3
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    References listed on IDEAS

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    1. Marvin Goodfriend, 2002. "Interest on reserves and monetary policy," Economic Policy Review, Federal Reserve Bank of New York, vol. 8(May), pages 77-84.
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    3. 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.
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    6. 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, September.
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    8. R. Spence Hilton & Warren B. Hrung, 2007. "Reserve levels and intraday federal funds rate behavior," Staff Reports 284, Federal Reserve Bank of New York.
    9. Bartolini, Leonardo & Bertola, Giuseppe & Prati, Alessandro, 2002. "Day-to-Day Monetary Policy and the Volatility of the Federal Funds Interest Rate," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 34(1), pages 137-159, February.
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    12. 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.
    13. Peter D. Sternlight, 1964. "Reserve Settlement Periods Of Member Banks: Comment," Journal of Finance, American Finance Association, vol. 19(1), pages 94-98, March.
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    Keywords

    Federal Reserve banks; Monetary policy;

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