Understanding Monetary Policy Implementation

FRB Richmond Economic Quarterly, Vol. 94, No. 3, Summer 2008, pp. 235-263

30 Pages Posted: 11 Dec 2012

See all articles by Huberto M. Ennis

Huberto M. Ennis

Federal Reserve Banks - Federal Reserve Bank of Richmond

Todd Keister

Rutgers, The State University of New Jersey - Department of Economics

Date Written: 2008

Abstract

The Federal Reserve implements its monetary policy objectives by intervening in the interbank market for overnight loans. In particular, it aims to change the supply of reserves available to commercial banks so that the (average) interest rate in this market equals an announced target rate. A recent change in legislation will give the Federal Reserve greater flexibility in this process by allowing it to pay interest on reserve balances. Together, the change and recent events in financial markets have renewed interest in the process of monetary policy implementation. This article presents a simple analytical framework for understanding this process. We use the framework to illustrate the main factors that influence a central bank’s ability to keep the market interest rate close to a target level. We also discuss how paying interest on reserves can be a useful policy tool in this regard.

Suggested Citation

Ennis, Huberto M. and Keister, Todd, Understanding Monetary Policy Implementation (2008). FRB Richmond Economic Quarterly, Vol. 94, No. 3, Summer 2008, pp. 235-263. Available at SSRN: https://ssrn.com/abstract=2187868

Huberto M. Ennis (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States

Todd Keister

Rutgers, The State University of New Jersey - Department of Economics ( email )

75 Hamilton Street
New Brunswick, NJ 08901
United States

HOME PAGE: http://econweb.rutgers.edu/tkeister

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