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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.

Suggested Citation

  • Huberto M. Ennis & Todd Keister, 2008. "Understanding monetary policy implementation," Economic Quarterly, Federal Reserve Bank of Richmond, issue 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

    1. Marvin Goodfriend, 2002. "Interest on reserves and monetary policy," Economic Policy Review, Federal Reserve Bank of New York, issue May, pages 77-84.
    2. 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.
    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.
    4. 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.
    5. Bech, Morten L. & Garratt, Rod, 2003. "The intraday liquidity management game," Journal of Economic Theory, Elsevier, vol. 109(2), pages 198-219, April.
    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.
    7. Guthrie, Graeme & Wright, Julian, 2000. "Open mouth operations," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 489-516, October.
    8. 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.
    9. R. Spence Hilton & Warren B. Hrung, 2007. "Reserve levels and intraday federal funds rate behavior," Staff Reports 284, Federal Reserve Bank of New York.
    10. 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.
    11. James J. 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.
    12. Todd Keister & Antoine Martin & James J. McAndrews, 2008. "Divorcing money from monetary policy," Economic Policy Review, Federal Reserve Bank of New York, issue 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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    Monetary policy ; Federal Reserve banks;


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