Transcript Federal funds rate

Lecture 29:
Monetary policy – part
one
Mishkin Ch15 – part A
page 373-378
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Tools of monetary policy
1.
Open market operations

2.
Changes in borrowed reserves (discount loans)

3.
Affect the monetary base
Changes in reserve requirements (required reserves
ratio)


Affect the quantity of reserves and the monetary base
Affect the money multiplier
Federal funds rate: the interest rate on overnight loans
of reserves from one bank to another

Primary indicator of the stance of monetary policy
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Demand in the market for
reserves
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
Quantity of demand: reserves
Price: federal funds rate – interest rate in the federal
funds market.
Reserves = required reserves + excess reserves


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Excess reserves are insurance against deposit outflows
The cost of holding these is the interest rate that could have
been earned
If federal funds rate decreases  the opportunity cost
of holding excess reserves falls  quantity of
reserves demanded rises
Downward sloping demand curve
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Supply in the market for
reserves
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
1.
2.
Quantity of supply = non-borrowed + borrowed
reserves
Price: federal funds rate
Cost of borrowing from the Fed is the discount rate,
and borrowing from the Fed is a substitute for
borrowing from other banks (in federal funds market)
If iff < id, then banks will not borrow from the Fed and
borrowed reserves are zero
The supply curve will be vertical
As iff rises above id, banks will borrow more and
more at id, and re-lend at iff
The supply curve is horizontal (perfectly elastic) at id
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Equilibrium
The equilibrium quantity of reserves and
federal funds rate occurs at the
intersection of the demand curve and
supply curve.
 Next question: how would changes in
using the three monetary policy tools
cause changes in the equilibrium federal
funds rate?

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Open market operations affect
federal funds rate
Open market purchase  Nonborrowed
part increase  supply curve shifts to
the right  the federal funds rate to fall
 An open market purchase causes the
federal funds rate to fall; an open market
sale causes the federal funds rate to rise.

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Change in discount rate might
affect federal funds rate

If the intersection of supply and demand occurs
on the vertical section of the supply curve, a
change in the discount rate will have no effect
on the federal funds rate.

If the intersection of supply and demand occurs
on the horizontal section of the supply curve, a
decrease in discount rate results in a fall in
federal funds rate, an increase in discount rate
leads to a rise in federal funds rate.
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Change in reserve requirement
affect federal funds rate

If required reserves ratio increases  banks
need more reserves  demand curve shifts to
the right  federal funds rate increase

When the Fed raises reserve requirement, the
federal funds rate rises and when the Fed
decreases reserve requirement, the federal
funds rate falls.
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