Academic journal article Federal Reserve Bank of New York Economic Policy Review

Monetary Policy and Open Market Operations during 1994

Academic journal article Federal Reserve Bank of New York Economic Policy Review

Monetary Policy and Open Market Operations during 1994

Article excerpt


In 1994, the operating techniques for implementing monetary policy remained similar to those of recent years; however, the Trading Desk at the Federal Reserve Bank of New York gained slightly more flexibility in its execution of open market operations after the Federal Open Market Committee began announcing its policy actions in February. As a consequence of the change in procedures, open market operations were no longer used to communicate policy shifts. Nearly all the Desk's operations added reserves because cumulative reserve shortages were substantial for the fourth consecutive year. These deficiencies reflected the continued rapid expansion of currency, which stemmed in part from heavy currency shipments abroad. Working in the other direction were declines in the demand for reserve balances arising from monetary policy tightening. Higher interest rates reined in the growth of transactions deposits and reduced the balances that banks were required to hold at the Federal Reserve. As these balances fell, banks lost some flexibility in managing their reserve positions, and by year-end the potential for operating difficulties associated with low balances had reemerged.

The next section of the report briefly reviews the course of monetary policy in 1994 and describes the responses of the fixed-income securities markets to economic and policy developments. Monetary policy moved away from the accommodative stance that had been in place for some time as the robust pace of economic growth cut into remaining excess productive capacity. With the economy expanding rapidly and the Federal Reserve acting to restrain inflationary pressures, interest rates moved sharply higher and the yield curve flattened. The extent of the rise in yields took many market participants by surprise, contributing to losses and a few bankruptcies, particularly by highly leveraged accounts.

The final section of this report discusses the Open Market Trading Desk's implementation of the objectives established by the Federal Open Market Committee (FOMC). It reviews policy techniques and factors affecting reserve supplies and demands over the year. In 1994, the Desk added a net $32 billion to its securities portfolio, the second largest annual increase. Repurchase agreements with relatively short maturities were used extensively by the Desk to manage reserves within two-week reserve maintenance periods; such transactions are well adapted to handle short-term variations in reserve levels and the frequent revisions to estimated reserve needs. In addition, pricing of daylight overdrafts, which began in April, had the potential to complicate policy implementation, but the actual effects on operations proved to be minimal.



Monetary policy in 1994 was formulated against a background of rapid economic growth and rising resource utilization but generally modest aggregate price increases. The FOMC increased reserve pressures at five of eight meetings and once between meetings, resulting in a cumulative increase of 2-1/2 percentage points in the federal funds rate (Table 1). (Table 1 omitted) Asymmetric directives indicating a greater likelihood that future changes in policy would be toward restraint were adopted at the three meetings where no change was made to existing pressures. Meanwhile, the Board of Governors approved three increases in the discount rate totaling 1-3/4 percentage points. When determining the stance of policy, the FOMC continued to monitor a broad range of economic and financial indicators. Annual targets were still set for the broader monetary aggregates, but the FOMC placed limited weight on the aggregates because of the considerable uncertainty that persisted about the behavior of their velocities.(1)

Economic background

The economic expansion remained on solid footing throughout 1994, with personal consumption, business investment, and inventory accumulation the mainstays of growth (Table 2). …

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