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Copyright © 2002 Pearson Education, Inc. Slide 20-1
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Copyright © 2002 Pearson Education, Inc. Slide 20-1
Copyright © 2002 Pearson Education, Inc. Slide 20-2
Chapter 20
Monetary Policy Tools
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Open Market Operations
Open market operations are Fed purchases and sales of securities in financial markets.
The Federal Open Market Committee (FOMC) guides open market operations.
Open market purchases are expansionary and open market sales are contractionary.
The FOMC issues a general directive stating its overall policy objectives.
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Types of Open Market Operations
Dynamic transactions are intended to change monetary policy.
Outright purchases and sales are types of dynamic transactions.
Defensive transactions are aimed at offsetting fluctuations in the base.
Repurchase and matched sale-purchase agreements are defensive transactions.
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Advantages of Open Market Operations
Control Flexibility Ease of implementation
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Discount Policy
Discount policy includes setting the discount rate and terms of discount lending.
The Fed influences the volume of discount loans by setting their price and terms.
The Fed discourages banks from heavy use of discount loans.
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Types of Discount Loans
Adjustment credit Seasonal credit Extended credit
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Advantages of Discount Policy
It is the most direct way for the Fed to act as a lender of last resort to the banking system.
Changes in the discount rate have an announcement effect.
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Figure 20.1 Discount Rate andFederal Funds Rate, 1970-2000
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Reserve Requirements Reserve requirements mandate that banks hold
part of their deposits in cash or Fed deposits. The Fed rarely changes reserve requirements. Every two weeks, the Fed monitors compliance
with its reserve requirements. Debate continues on what the Fed’s role should
be in setting reserve requirements.
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Fed Watching: Analyzing the Policy Tools
The market for reserves is also known as the federal funds market.
Banks’ demand for federal funds increases as the federal funds rate declines.
The supply of reserves is the supply by the Fed of borrowed and nonborrowed reserves.
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Figure 20.2 Equilibrium in the Federal Funds Market
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Effects of Changes in Policy
An open market purchase decreases the equilibrium federal funds rate.
An increase in the discount rate increases the equilibrium federal funds rate.
An increase in reserve requirements increases the equilibrium federal funds rate.
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Figure 20.3 Effects of Open Market Operations
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Figure 20.4 Effects of Changes in the Discount Rate
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Figure 20.5 Effects of Changes in Required Reserves
