Timeliness and the Fed's Daily Tactics
Fullwiler, Scott T., Journal of Economic Issues
A recent development in neoclassical monetary economics is the flurry of research on the Federal Reserve's (hereafter, the Fed's) daily implementation of monetary policy in the federal funds market. In the late summer of 2001, for instance, a Federal Reserve Bank of New York symposium on monetary policy offered five papers on the subject (Demiralp and Jorda 2002; Bennett and Peristiani 2002; Krieger 2002; Goodfriend 2002; Woodford 2002) while the July/August 2001 edition of the Federal Reserve Bank of St. Louis Review provided two more (Taylor 2001; Thornton 2001).
Prior to the mid 1990s, the daily implementation of monetary policy had been, relative to recent trends, a neglected area of research among neoclassicals, other than Joshua Feinman's (1993) paper on the Fed's daily reaction function. Research on the Fed's actions generally abstracted from the Open Market Desk's (hereafter, the Desk's) daily actions in the federal funds market, concentrating instead upon the strategy involved in setting intermediate targets as in the monetary policy rule and measuring monetary policy literatures. On the other hand, research on the daily federal funds market primarily examined banks as lenders and borrowers of overnight funds, while abstracting from the Desk's interventions in the market (e.g., Ho and Saunders 1985; Spindt and Hoffmeister 1988; Lasser 1992; Griffiths and Winters 1995).
During the mid to late 1990s, falling required reserves due to the proliferation of retail sweep accounts left banks at risk of overdrawing their reserve accounts during the course of routine settlement of electronic payments. The result was a substantially increased daily volatility in the federal funds rate that both complicated the implementation of monetary policy and provided impetus for new research on the supply and demand forces in the daily federal funds market (1) (Bartolini et al. 2001, 2002; Bennett and Hilton 1997; Clouse and Elmendorf 1997; Demiralp and Jorda 2000; Furfine 2000; Thornton 1999, 2001; Woodford 2002). Several leading journals have since devoted entire issues on complementary topics, such as the implementation of monetary policy in the information age (Posen 2000), monetary policy implementation when inflation and interest rates are both at or near zero (2) (Fuhrer and Sniderman 2000), and the daily operating procedures of various central banks (Underhill 2002). Clearly, analysis of the Desk's daily activities in the federal funds market now has an important role in the neoclassical monetary economics literature.
Unlike neoclassicals, Post Keynesians had already been incorporating the Fed's implementation of monetary policy in the federal funds market within the endogenous money literature. Though this is not the place for a complete treatment of this literature (see Moore 1988 or Wray 1990, 1998), a key argument is that reserves are not an exogenously controllable variable for the Fed; rather, changes to reserves must he made endogenously in response to changes in banks' demand for reserves. This argument contributes significantly to the views of adherents on several key macroeconomic issues, including the transmission of monetary policy, the proper intermediate targets for monetary policy, and the proper goals of monetary policy. Reserve endogeneity also complements recent contributions made by Post Keynesians to neo-Chartalist literature on functional finance and the inter-relationship/appropriate mix of monetary and fiscal policies (e.g., Wray 1998; Bell 2000).
This paper contributes to the monetary economics literature in general by providing a detailed analysis of the Fed's current daily tactics, while also serving as a statement on this topic from an institutionalist perspective. The purpose of the paper is the application of an institutionalist "way to go about thinking" to the implementation of monetary policy in the federal funds market through an examination of how timeliness is achieved in the Fed's daily tactics. …