Chapter 5

Chapter 13: The Tools and Goals of Central Bank Monetary
Learning Objectives
 Understand how the policy tools available to central banks around the world really work in carrying out money and credit policies and in affecting the cost and availability of loanable funds. o How the Federal Reserve System controls credit and interest rate levels inside the United States, the various ways in which central bank policy actions affect a nation’s economic goals, including control over inflation and sustaining adequate economic growth and maximum employment.  You will learn about the difficulties that central banks face in achieving their policy goals, such as conflicting goals (stimulation versus inflation) Fed Tools:
1) Open market operations: affect the level and growth of legal reserves, which in turn
affect interest rates. (Note the T-accounts on page 412).
The System Open Market Account (SOMA) manager carries out the policies set by the
FOMC by trading in securities through the System’s Trading Desk; trading activities of
the SOMA manager are guided by a policy directive issued to the Federal Reserve Bank
of New York following the conclusion of each meeting of the FOMC.
After its meetings the FOMC has also been issuing a policy statement in recent years which summarizes its view of current economic developments and its planned course of action. As an added check on the decisions of the SOMA manager, a conference call between staff economists at the Federal Reserve Board, a member of the FOMC, and the SOMA manager is held each day before trading occurs. Basically, the FOMC asks the SOMA manager to use the open market policy tool in an effort to achieve a target range or level for a key money market interest rate – the
average rate on Federal funds loans. In the event that the Federal funds rate drifts outside
this range, the SOMA manager must notify the chairperson of the Federal Reserve Board
for further instructions.
Transaction types:
Straight transaction: the sale or purchase of securities in which outright title passes to
the buyer on a permanent basis (used for a ―once-and-for-all‖ change in reserves).
Repurchase agreement (RP): the Fed will buy securities but will agree to sell them back
within a short period of time, usually the following day ( temporary change in reserves).
Runoff: Fed will deal directly with the U.S. Treasury to purchase securities or redeem
maturing securities for cash.
Agency operations: Fed conducts purchases and sales of securities on behalf of foreign
central banks and other official agencies and institutions that hold accounts with the New
York Federal Reserve Bank.
Try Problem 1
2) Discount window: Depository institutions borrow short-term funds infrequently from
the central bank to meet liquidity needs. For institutions that borrow regularly, they
merely contact their central bank and have the funds credited.
Because of the possible negative effect the discount rate is changed infrequently, often
lagging behind other interest rates. (T-accounts on page 422)
3) Reserve requirement: The reserve requirement (the Fed’s most potent policy tool)
affects depository institutions in 3 ways. a) It affects the deposit multiplier, the money
multiplier, and the mix of excess and required reserves. b) principal advantage: can
carry out major shifts in government policy. c) principal disadvantage – this tool is so
powerful that it is inflexible and cannot be used often. (T-accounts on page 429)
4) Margin Requirement: enacted into law when the Securities Exchange Act of 1934
was passed, limit the amount of credit that may be used to purchase and carry certain
securities when those same securities are to be used as collateral for the loan.

The purpose of the margin requirement is to limit purchases of regulated securities and limit poorly collateralized security-based loans. (owe its origin to the
Great Depression of the 1930s).
Try Problem 2 and 4
Interest-rate targeting? In recent years, the Federal Reserve has given increasing weight
to targeting the cost and availability of credit in the money market (in particular, the daily
average interest rate on federal funds transactions). The Fed adopted a federal funds
interest rate targeting procedure.
When the Fed sells securities, the supply of reserves available to depository institutions is reduced and, other things held equal, the Fed funds rate—the interest rate changed on overnight borrowing of reserves in the banking system—tends to rise. On the other hand, a Federal Reserve purchase of securities increases available reserves to depository institutions, which tends to push the Fed funds rate down. The Fed achieves its target through open market operations that impact primarily the nonborrowed reserves (and hence the total reserves) available to the banking system. Note the targets and potential conflicts.

Source: http://www.business.mnsu.edu/bbuthq1/FINA464/Lectures/Chapter%2013.pdf