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Unformatted text preview: 30/9/2010 1 Chapter 8C Tools of Monetary Policy Tools of Monetary Policy • Open market operations – Affect the quantity of reserves and the monetary base Affect the quantity of reserves and the monetary base • Changes in borrowed reserves – Affect the monetary base • Changes in reserve requirements – Affect the money multiplier Federal funds rate: the interest rate on overnight loans of • Federal funds rate: the interest rate on overnight loans of reserves from one bank to another – Primary instrument of monetary policy 30/9/2010 2 Demand in the Market for Reserves • What happens to the quantity of reserves demanded by banks, holding everything else constant, as the federal funds rate changes? • Excess reserves are insurance against deposit outflows – The cost of holding these is the interest rate that The cost of holding these is the interest rate that could have been earned minus the interest rate that is paid on these reserves, i er Demand in the Market for Reserves • Since the fall of 2008 the Fed has paid interest on reserves at a level that is set at a fixed amount below the federal funds rate target. • When the federal funds rate is above the rate paid on excess reserves, i er , as the federal funds rate decreases, the opportunity cost of holding excess reserves falls and the quantity of reserves demanded rises • Downward sloping demand curve that becomes flat (infinitely Downward sloping demand curve that becomes flat (infinitely elastic) at i er 30/9/2010...
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- Spring '12