1. PowerPoint Presentation by Charlie Cook Copyright © 2004 South-Western. All rights reserved. Chapter 20 Fed Operating Procedures

2. Copyright © 2004 South-Western. All rights reserved.20–2 Fundamental Issues 1.What are the key instruments of monetary policy? 2.What key factors affect the demand for reserves by depository institutions? 3.How do Federal Reserve policies influence the supply of reserves to depository institutions and the federal funds rate? 4.How is the federal funds rate related to other market interest rates?

3. Copyright © 2004 South-Western. All rights reserved.20–3 Fundamental Issues (cont’d) 5.How do Federal Reserve policies affect the quantity of money? 6.What are Federal Reserve operating procedures, and what operating procedures has the Federal Reserve used in recent years?

4. Copyright © 2004 South-Western. All rights reserved.20–4 Open Market Operations Outright transactions:  An open market purchase or sale in which the Fed is not obliged to resell or repurchase securities at a later date. Repurchase-agreement transactions:  Contracts that commit the seller of a security to repurchase the security at a later date. Reverse repurchase agreements:  Agreements for the Fed to repurchase the securities from dealers at a later time.

5. Copyright © 2004 South-Western. All rights reserved.20–5 Fed Open Market Transactions during 2002 ($Millions) Table 19–1 Outright transactions: Sales Purchases$ 45,357 Sales and redemptions 1,429 Repurchase agreements and matched transactions: Purchases4,677,597 Sales4,715,526 Net change in Federal Reserve System open market account 5,999 SOURCE: Board of Governors of the Federal Reserve System, Federal Reserve Bulletin, July 2002; authors’ estimates.

6. Copyright © 2004 South-Western. All rights reserved.20–6 A Multiplier View Of The Effects Of Open Market Operations M = money MB = monetary base TC = total credit m M = money multiplier NBR = non borrowed reserves

7. Copyright © 2004 South-Western. All rights reserved.20–7 The Discount Rate, Money, And Credit In The Multiplier Model “Discounting”:  Federal Reserve bank increases an institution’s reserve account by more than the value of the institution’s deposited U.S. government securities.  Institution buys back the securities at true value. Spread:  The difference, or spread, between the federal funds rate and the discount rate. Reserve Requirements

8. Copyright © 2004 South-Western. All rights reserved.20–8 The Federal Funds Rate and Excess Reserves The opportunity cost of holding excess reserves.  Holding reserves as vault cash or as reserve deposits with Federal Reserve banks yields no interest return to depository institutions. The inverse relationship between the federal funds rate and excess reserves  This reasoning implies that the demand for excess reserves by depository institutions should be inversely related to the federal funds rate.

9. Copyright © 2004 South-Western. All rights reserved.20–9 The Demand for and Supply of Total Depository Institution Reserves Figure 20–1

10. Copyright © 2004 South-Western. All rights reserved.20–10 The Supply of Depository Institution Reserves The discount window and borrowed reserves  Open market operations and nonborrowed reserves  Fed’s supply of total depository institution reserves

11. Copyright © 2004 South-Western. All rights reserved.20–11 Factors That Determine the Equilibrium Federal Funds Rate Figure 20–2

12. Copyright © 2004 South-Western. All rights reserved.20–12 The Market for Reserves, Interest Rates, and the Quantity of Money The risk structure of interest rates:  Instruments of identical maturity have different market yields due different degrees of risk. The term structure of interest rates:  Instruments of similar risk have different market yields if have different terms to maturity. The federal funds and treasury security yield curves:  Yield curves for federal funds and treasury securities reflect their risk premium differences.

13. Copyright © 2004 South-Western. All rights reserved.20–13 Determining the Treasury Bill Rate Figure 20–3

14. Copyright © 2004 South-Western. All rights reserved.20–14 Determining the Equilibrium Quantity of Money Figure 20–4

15. Copyright © 2004 South-Western. All rights reserved.20–15 Linking Fed Policy Tools to the Quantity of Money Figure 20–5

16. Copyright © 2004 South-Western. All rights reserved.20–16 Federal Reserve Operating Procedures Monetary policy strategy:  A general plan for achieving some set of economic objectives. An operating procedure:  A self-imposed guideline for conducting monetary policy over a horizon stretching across several weeks or months.  Alternative operating procedures  A reserves-targeting procedure  A federal-funds-rate-targeting procedure

17. Copyright © 2004 South-Western. All rights reserved.20–17 Inducing an Increase in the Quantity of Money Figure 20–6

18. Copyright © 2004 South-Western. All rights reserved.20–18 Reserve- versus Interest-Rate-Oriented Operating Procedures Figure 20–7

19. Copyright © 2004 South-Western. All rights reserved.20–19 Variability of the Federal Funds Rate and M1 Growth under Different Operating Procedures Figure 20–8 SOURCES: Carl E.Walsh,“Issues in the Choice of Monetary Policy Operating Procedures,” in Monetary Policy for a Changing Financial Environment, ed.William Haraf and Phillip Cagan (Washington, D.C.: AEI Press,1990), pp.8–37.

20. Copyright © 2004 South-Western. All rights reserved.20–20 Figure 20–6 Sweep Accounts and Reserves of U.S. Depository Institutions at Federal Reserve Banks