Academic journal article Federal Reserve Bulletin

Domestic Open Market Operations during 2000

Academic journal article Federal Reserve Bulletin

Domestic Open Market Operations during 2000

Article excerpt

This report was adapted from one presented to the Federal Open Market Committee by Peter R. Fisher, Executive Vice President of the Federal Reserve Bank of New York. Spence Hilton was primarily responsible for the preparation of this report, with the assistance of many others in the Markets Group at the Federal Reserve Bank of New York.

IMPLEMENTATION OF MONETARY POLICY IN 2000

Directives of the Federal Open Market Committee

In 2000, the directives issued by the Federal Open Market Committee (FOMC) instructed the Trading Desk at the Federal Reserve Bank of New York to foster conditions in the market for reserves consistent with maintaining the federal funds rate at an average around a specified rate. This indicated rate is commonly referred to as the federal funds rate target. The FOMC raised the federal funds target 1 percentage point in three steps over the year, to a level of 6 1/2 percent (table 1). Each rate change was decided at a scheduled meeting. On each of these three occasions, the Board of Governors approved an equal-sized increase in the discount rate.

1. Changes in the federal funds rate specified in directives
of the Federal Open Market Committee

Percent
                      Expected
Date of change      federal funds   Discount rate
                       rate

November 16, 1999      5 1/2          5
February 2, 2000       5 3/4          5 1/4
March 21, 2000         6              5 1/2
May 16, 2000           6 1/2          6

The FOMC implemented modifications to its disclosure procedures at its February meeting.(1) These new procedures included the adoption of new language to describe the Committee's judgment about the economic outlook and were designed to enhance communication to the public, but they had no implications for the conduct of monetary operations between meetings.

Overview of Operating Procedures and Practices to Influence the Federal Funds Rate

The Desk uses open market operations to align the supply of balances held by depository institutions at the Federal Reserve--or Fed balances--with the demand for holding balances. The average level of balances that banks demand over two-week reserve maintenance periods is in large measure determined by their requirements for reserve balances and clearing balances, with only a relatively small level of additional, or excess, balances typically demanded.(2) The ability of depository institutions to average their holdings of balances at the Federal Reserve over two-week periods to meet their requirements gives them flexibility in managing their accounts from day to day, which helps limit the volatility in rates that can develop when the Desk misestimates either the supply of or demand for balances. Nonetheless, the funds rate will firm if the level of balances falls so low that some banks have difficulty finding sufficient funds to cover late-day deficits in their Federal Reserve accounts, and the rate will soften if balances are so high that some banks risk ending a period holding unusable excess reserve balances.

Each morning, the Desk considers whether open market operations are needed based on estimates of the supply of and demand for balances and taking into account possible forecast errors and minimal levels of aggregate Fed balances that in practice are needed to facilitate settlement of wholesale financial payments by banks. Any operation designed to alter balances that same day is typically arranged shortly afterward. When the funds rate is near target, the Desk aims to supply a level of Fed balances that equilibrates the expected cost that banks associate with borrowing at the discount window to avoid ending a day overdrawn in their Fed account (or finishing a period short of their requirements) with the expected cost of holding unusable excess balances. When the funds rate deviates from the target, the Desk adjusts the level of Fed balances it aims to supply in the appropriate direction. …

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