Academic journal article Federal Reserve Bulletin

Open Market Operations during 1997

Academic journal article Federal Reserve Bulletin

Open Market Operations during 1997

Article excerpt

This article is adapted from a report to the Federal Open Market Committee by Peter R. Fisher, Executive Vice President of the Federal Reserve Bank of New York and Manager of the System Open Market Account. Virginia Cheng, Spence Hilton, and Ted Tulpan were primarily responsible for the preparation of this report. Many other members of the Markets Group assisted in the preparation; Annemarie Gemma and David Parseghian provided invaluable research support.

IMPLEMENTATION OF MONETARY POLICY IN 1997

Operating Procedures and Practices

In 1997 the Trading Desk (Desk) at the Federal Reserve Bank of New York managed reserve conditions with the objective of maintaining the federal funds rate around the level desired by the Federal Open Market Committee. The FOMC tightened monetary policy at its March meeting, raising the intended federal funds rate from 5 1/4 percent to 5 1/2 percent, the level at which it was held over the remainder of the year (table 1). There was no associated change in the discount rate.

1. Federal Open Market Committee meeting dates and policy rates, December 17, 1996-December 16, 1997

                   Expected
                   federal funds   Discount rate
Date of meeting    rate            (percent)
                   (percent)

12/17/96               5.25            5.00
2/4 to 2/5/97          5.25            5.00
3/25/77                5.50            5.00
5/20/97                5.50            5.00
7/1 to 7/2             5.50            5.00
8/19/97                5.50            5.00
9/30/97                5.50            5.00
11/12/97               5.50            5.00
2/16/97                5.50            5.00

The Committee's directives instruct the Desk to maintain the federal funds rate on average around a specified level. Open market operations are used to provide a level of nonborrowed reserves that will allow the federal funds market to clear at the indicated rate. Each day, the Desk aims to keep the rate as close as possible to the targeted level with a minimum of volatility. But in deciding each day's operations, the Desk also considers how its flexibility for arranging operations in upcoming days might be affected by that day's course of action as well as how the behavior of the funds rate that day might influence rates in subsequent days.

At the start of each two-week maintenance period, a strategy for meeting reserve needs is developed that is consistent with the estimated demand for excess reserves and the expected reserve supply arising from discount window borrowing. These estimates are captured in the Desk's allowances for excess and borrowed reserves made each period.(1) The reserve management strategy also depends on the estimated daily pattern of reserve supply and demand. The approach must be flexible enough to allow for the inevitable revisions to the reserve estimates, and as a period unfolds, the Desk will also respond to the observed behavior of the federal funds rate, which may prompt some reassessment of daily or period needs. Each morning, this process of developing a strategy both for the day and for the remainder of the maintenance period is repeated.

In deciding on open market operations each day, the Desk takes account of the estimates of reserve supply; any special factors that may raise or lower the need for excess reserves, such as high or uncertain payment flows; cumulative excess holdings to that point in the period; the number of days remaining until the settlement day; and the risks seen in the reserve estimates. If the federal funds rate is trading away from its desired level at the time of the operation, the Desk may adjust the daily level of excess reserves it aims to provide to contain pressures in the financing markets and to steer the rate back toward its desired level in later trading. Responding inadequately to current rate pressures increases the likelihood that these pressures will become self-reinforcing and influence rates in upcoming days. …

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