Identifying monetary policy with a model of the federal funds rate
With a stochastic general equilibrium model, we highlight the role of both monetary policy and banks in determining the relationship between the federal funds rate and bank reserves. Monetary policy consists of a stochastic upward-sloping supply schedule for reserves, along with a discount window and open-market operations that are consistent with this schedule. The demand schedule for reserves by banks is downward sloping in the federal runds rate, so shifts in the supply schedule lead to a negative relationship between total reserves and the federal funds rate (a liquidity effect). Shifts in the demand schedule lead to a positive relationship, so the net effect over time depends on the relative magnitude of demand and supply shocks. The model with these featues is simulated and compared to U.S. data.
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