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Slide 20-1
Chapter 20
Monetary Policy Tools
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Slide 20-2
Open Market Operations
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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
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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
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Control
Flexibility
Ease of implementation
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Discount Policy
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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
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Adjustment credit
Seasonal credit
Extended credit
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Advantages of Discount Policy
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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 and
Federal Funds Rate, 1970-2000
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Reserve Requirements
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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
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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
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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
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