That increase shifted the supply curve far to the right - to the horizontal part of the demand curve.Īt this point, reserves were much more than “limited.” At the peak, people described the quantity of reserves in the banking system as abundant or even super abundant! You see, in response to the financial crisis, the FOMC lowered its target for the federal funds rate to near zero, and increased the level of reserves from around $15 billion (in 2007) to over $2.7 trillion (in late 2014). The Great Financial Crisis of 2007-09 changed a lot of things - including the way the Fed implements monetary policy. The Financial Crisis Changed the Fed’s Toolbox In contrast, sales of securities would reduce the supply of reserves, thereby shifting the supply curve to the left and moving the FFR higher. government securities would increase the supply of reserves in the banking system, thereby shifting the supply curve to the right and moving the federal funds rate (FFR) lower. Those are the old days.Ī Primary Tool before the Financial Crisis
In retrospect, we now refer to that model as the “limited reserves” framework. government securities - to shift the supply curve right or left (along the x-axis) and adjust the FFR lower or higher (along the y-axis).Īnd, your textbook probably mentioned two other tools - the discount rate and reserve requirements - and said that the Fed could increase or decrease either or both of these to influence bank lending, and thereby the growth of the money supply. In this model of the money market, the Fed could use open market operations - the purchase or sale of U.S. Your textbook might have had a graph like the one below.
#IF THE FED WANTS TO INCREASE THE FEDERAL FUNDS RATE IT WILL PLUS#
(Reserves are the cash banks hold in their vaults plus the deposits they maintain at Federal Reserve banks, and reserves influence the supply of money and credit in the economy.) government securities, it increases or decreases the level (or supply) of reserves in the banking system. It does this primarily by using daily open market operations. The Fed uses its monetary policy tools to influence the supply of money and credit in the economy. The story went something like this: The Federal Open Market Committee (FOMC), which is the main policymaking body of the Fed, sets a desired target for the federal funds rate (FFR) to move the economy toward the dual mandate. Do you remember the economics course you took in high school or college? You might recall memorizing the three tools of monetary policy that help the Federal Reserve achieve its congressional mandate of maximum employment and price stability.
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