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Unformatted text preview: rates of interest make it more expensive for households and businesses to keep their funds in low– or non–yielding forms such as checkable deposits or currency. Households and businesses therefore attempt to reduce the average amount of money they keep on hand when interest rates are high. Conversely, they are willing to hold larger cash balances when interest rates are low. The open market interest rate over which the Federal Reserve has the most direct influence is the federal funds rate. This is the rate which banks pay when they borrow reserves from one another. The Federal Reserve can influence this rate via open market operations which alter the amount of non–borrowed reserves available. Sustained changes in the federal funds rate generally lead to corresponding movements in other short–term interest rates, which in turn affect the public's willingness to hold money. In short, the Federal Reserve could dampen money growth by exerting upward pressure on interest rates through open market sales to drain reserves; the higher interest rates would reduce the public's demand for money and cause monetary growth to slow. Similarly, downward pressure on interest rates can be expected ultimately to produce faster money growth. SHIFT TO A RESERVES OPERATING PROCEDURE
While an improvement over the use of interest rates as indicators of monetary policy, the funds rate operating procedure, as it was called, was also flawed. With hindsight, it became evident that the funds rate sometimes was slow to adjust to changing economic conditions. This meant money growth tended to speed up when the economy picked up, Dynasty School (www.dynastySchool.com) 2-27 REAL ESTATE FINANCE
and to fail off when the economy weakened, that is, monetary growth continued to show a pro–cyclical bias, as before. To solve this problem, the Federal Reserve adopted a new operating procedure on October 6, 1979 through which it sought to achieve its targets for money by placing less emphasis on interest rates and focusing more on the volume of reserves available to depository institutions. The new procedure, in other words, place...
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This note was uploaded on 12/30/2010 for the course SOC 101 taught by Professor Zhung during the Spring '10 term at Punjab Engineering College.
- Spring '10