The Fed's New Monetary Policy Tools

Introduction

• The Federal Reserve (Fed) has a mandate to promote maximum employment and price stability.
• The approach and tools for monetary policy have evolved, especially since the 2007-09 Financial Crisis.

Federal Reserve's Monetary Policy Implementation

• Goals: Maximum employment and stable prices.
• Before 2008: Implemented with limited reserves, relying on open market operations.
• After 2008: Implementation shifted to using ample reserves and focus on administered rates.

Teaching Monetary Policy

• FOMC sets monetary policy stance affecting employment and inflation.
• Changes in reserve levels and tools before and after 2008 impact the federal funds rate (FFR) and short-term rates.

Old Framework: Limited Reserves

• Reserve Types: Required and excess reserves.
• Market Operations: Banks borrowed/lent reserves impacting the FFR.
• Tools:
  • Reserve requirements.
  • Open market operations - buying/selling U.S. Treasury securities to influence FFR.
  • Discount rate - set by Fed, capped borrowing rates.

Impact of the Financial Crisis

• Response: Lowered FFR to near zero and introduced a target range for FFR.
• New Tools: Interest on reserve balances (IORB) for required & excess reserves.

New Framework: Ample Reserves

• Characteristics: Large quantity of reserves, making small supply changes ineffective.
• Tools:
  • IORB - primary tool to influence FFR.
  • ON RRP - supplementary tool acting as a floor for FFR.

Monetary Policy Tools Comparison

• Limited-Reserves Framework:
  • Relied on open market operations to adjust reserve supply and FFR.
  • Supply curve shifts influenced FFR significantly.
• Ample-Reserves Framework:
  • Uses IORB and ON RRP rates to guide FFR.
  • Small supply shifts have minimal effect on FFR.

Implementation During Economic Strain

• Limited-Reserves Framework: Struggles during large reserve increases (e.g., Financial Crisis).
• Ample-Reserves Framework: Effective in handling large economic shocks (e.g., COVID-19 pandemic).

Summary

• Importance for Instructors: Need to understand the current framework for accurate teaching.
• Framework Comparison: The ample-reserves framework allows continued operation under stress and uses IORB as a key tool.

Related Topics

• Federal Reserve, Monetary Policy, Business Cycle

Authors

• Jane E. Ihrig, Senior Adviser and Economist, Federal Reserve Board of Governors.
• Scott A. Wolla, Economic Education Officer, St. Louis Fed.

Glossary

• Federal funds rate (FFR), Federal Open Market Committee (FOMC), Interest on reserve balances (IORB), etc.