im20 - Chapter 20 Monetary Policy Tools Overview This...

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Chapter 20 Monetary Policy Tools Overview This chapter describes the Fed’s use of monetary policy tools. Some understanding of how the tools are used is necessary if students are to fully appreciate how monetary policy works. The chapter gives a particularly detailed analysis of the role of the account manager at the New York Federal Reserve Bank in implementing monetary policy. The distinction between defensive and dynamic open market operations is made and reasons for the vagueness of FOMC policy directives to the account manager are discussed. The chapter discusses changes in the discount rate and in the required reserve ratio. Although these tools are less important than open market operations, they tend to be unduly neglected in many texts. The chapter concludes by tying together the earlier discussion of monetary policy tools with a graphical analysis of their impact on the federal funds market. The graphical analysis can be emphasized by those instructors wishing to make a more formal presentation of the material or skipped by instructors who feel that the qualitative discussion is sufficient. As a whole, the chapter gives a much more complete picture of how the Fed carries out policy than do discussions focusing almost entirely on open market operations and the activities of the FOMC and omitting direct analysis of the determinants of the federal funds rate. Needless to say, instructors in policy- oriented courses will want to stress the material in this chapter. Outline I. Open Market Operations A) Open market operations , the purchases and sales of securities in financial markets by the Fed, are the dominant means by which the Fed changes the monetary base. 1. The Fed began to use open market purchases as a policy tool during the 1920s. 2. The lack of intervention by the Fed during the bank crisis of the early 1930s led Congress to establish the Federal Open Market Committee (FOMC) to guide open market operations. 3. Open market purchases are viewed as expansionary and open market sales are viewed as contractionary. B) The FOMC meets eight times a year and issues a general directive stating its overall objectives for monetary aggregates and interest rates. 1. The Federal Reserve System’s account manager is responsible for carrying out open market operations that fulfill the FOMC’s objectives. 2. The Open Market Trading Desk , a group of traders at the Federal Reserve Bank of New York, trades government securities over the counter electronically with primary dealers. 3. The account manager can conduct open market operations through outright purchases and sales of Treasury securities or by using Federal Reserve repurchase agreements (analogous to commercial bank repos).
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114 Hubbard • Money, the Financial System, and the Economy, Sixth Edition 4. For open market sales, the trading desk often engages in matched sale-purchase transactions (or reverse repos) in which the Fed sells securities to dealers who agree to sell them back to the Fed in the near future. 5. Open market operations intended to change monetary policy are known as
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im20 - Chapter 20 Monetary Policy Tools Overview This...

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