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Understanding monetary policy implementation

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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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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Keywords: Monetary policy ; Federal Reserve banks;

References listed on IDEAS
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  1. Adam Ashcraft & James McAndrews & David Skeie, 2009. "Precautionary reserves and the interbank market," Staff Reports 370, Federal Reserve Bank of New York.
  2. Guthrie, Graeme & Wright, Julian, 2000. "Open mouth operations," Journal of Monetary Economics, Elsevier, vol. 46(2), pages 489-516, October.
  3. Leonardo Bartolini & Giuseppe Bertola & Alessandro Prati, 2000. "Day-to-day monetary policy and the volatility of the federal funds interest rate," Staff Reports 110, Federal Reserve Bank of New York.
  4. Marvin Goodfriend, 2002. "Interest on reserves and monetary policy," Economic Policy Review, Federal Reserve Bank of New York, issue May, pages 77-84.
  5. 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.
  6. 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.
  7. 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.
  8. 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.
  9. 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.
  10. Peter D. Sternlight, 1964. "Reserve Settlement Periods Of Member Banks: Comment," Journal of Finance, American Finance Association, vol. 19(1), pages 94-98, 03.
  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. Spence Hilton & Warren B. Hrung, 2007. "Reserve levels and intraday federal funds rate behavior," Staff Reports 284, Federal Reserve Bank of New York.
  13. 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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Cited by:

  1. Morten Bech & Todd Keister, 2012. "On the liquidity coverage ratio and monetary policy implementation," BIS Quarterly Review, Bank for International Settlements, December.
  2. Gara Afonso & Ricardo Lagos, 2014. "Trade Dynamics in the Market for Federal Funds," NBER Working Papers 20419, National Bureau of Economic Research, Inc.
  3. Morten L. Bech & Todd Keister, 2013. "Liquidity regulation and the implementation of monetary policy," BIS Working Papers 432, Bank for International Settlements.
  4. Morten L Bech & Cyril Monnet, 2013. "The Impact of Unconventional Monetary Policy on the Overnight Interbank Market," RBA Annual Conference Volume, in: Alexandra Heath & Matthew Lilley & Mark Manning (ed.), Liquidity and Funding Markets Reserve Bank of Australia.
  5. Judson, Ruth A. & Klee, Elizabeth, 2010. "Whither the liquidity effect: The impact of Federal Reserve open market operations in recent years," Journal of Macroeconomics, Elsevier, vol. 32(3), pages 713-731, September.
  6. Andreas Hornstein, 2010. "Monetary policy with interest on reserves," Economic Quarterly, Federal Reserve Bank of Richmond, issue 2Q, pages 153-177.
  7. Morten L. Bech & Elizabeth Klee, 2010. "The mechanics of a graceful exit: interest on reserves and segmentation in the federal funds market," Finance and Economics Discussion Series 2010-07, Board of Governors of the Federal Reserve System (U.S.).
  8. Ennis, Huberto M., 2014. "A Simple General Equilibrium Model of Large Excess Reserves," Working Paper 14-14, Federal Reserve Bank of Richmond.
  9. Arto Kovanen, 2011. "Monetary Policy Transmission in Ghana; Does the Interest Rate Channel Work?," IMF Working Papers 11/275, International Monetary Fund.
  10. 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 -.
  11. 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.
  12. Judson, Ruth A. & Klee, Elizabeth, 2011. "Big bank, small bank: Monetary policy implementation and banks' reserve management strategies," Journal of Economics and Business, Elsevier, vol. 63(4), pages 306-328, July.
  13. Todd Keister & James J. McAndrews, 2009. "Why are banks holding so many excess reserves?," Current Issues in Economics and Finance, Federal Reserve Bank of New York, vol. 15(Dec).
  14. Afonso, Gara M. & Lagos, Ricardo, 2014. "The Over-the-Counter Theory of the Fed Funds Market: A Primer," Working Papers 711, Federal Reserve Bank of Minneapolis.
  15. Antoine Martin & James McAndrews & Ali Palida & David Skeie, 2013. "Federal Reserve tools for managing rates and reserves," Staff Reports 642, Federal Reserve Bank of New York.
  16. 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.

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