Monetary Policy and Investment Opportunities

By Laura S. Nowak | Go to book overview

3
The Effect of Federal Reserve Open Market Operations on Short-Term and Long-Term Interest Rates

Open market operations have a decisive effect on short-term interest rates and some effect on long-term interest rates as well. The Fed can alter short- term nominal interest rates temporarily, but it is not clear that the Fed can alter long-term rates because long-term rates incorporate expectations about inflation over a longer time span. Since open market operations may affect money supply growth and future inflation, attempts to lower rates can actually raise them.

Sometimes the Fed enters the market to stabilize credit conditions and interest rates (defensive open market operations) and sometimes to make a change in credit conditions and interest rates (dynamic open market operations). To measure the effect of open market operations on interest rates, we would have to know whether the intervention in the open market was designed to smooth or to change current conditions. We would also have to know what other factors were at work at the same time. This information, unfortunately, is not readily available. The general intentions of the Federal Open Market Committee are made public approximately six weeks after their meeting, while the specific intentions of daily interventions are not made public at all. The investing public is left to guess whether the open market operations on a particular day, week, or month were designed to smooth out the market or to change conditions in the market. 1

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