The Federal Reserve's Tools for Policy Normalization in a Preferred Habitat Model of Financial Markets

38 Pages Posted: 8 Nov 2014

See all articles by James A. Clouse

James A. Clouse

Board of Governors of the Federal Reserve System - Monetary and Financial Market Analysis Section

Jane E. Ihrig

Federal Reserve Board - International Financial Transactions

Elizabeth Klee

Board of Governors of the Federal Reserve System

Han Chen

Federal Reserve Banks - Federal Reserve Bank of New York

Date Written: October 7, 2014

Abstract

This paper develops a model of the financial system that provides a framework for analyzing monetary policy implementation in a world with multiple Federal Reserve liabilities and a superabundant supply of reserves. The analysis demonstrates that the Federal Reserve's suite of policy tools including interest on excess reserves (IOER), overnight and term reverse repurchase agreements, and term deposits should allow the Federal Reserve to raise the level of short-term interest rates at the appropriate time. The model also demonstrates that these tools could be used in different ways to achieve any given desired level of interest rates. The choices among alternative combinations of tools, of course, have implications for patterns of financial intermediation. Specifically, the quantity of Federal Reserve liabilities held outside of the banking system is shown to depend importantly on the spread between various policy rates.

Keywords: Policy normalization, preferred habitat, financial markets, Federal Reserve liabilities, interest on excess reserves (IOER), overnight and term reverse repurchase agreements (ON and term RRP), term deposits (TDF)

JEL Classification: E5, G1

Suggested Citation

Clouse, James A. and Ihrig, Jane E. and Klee, Elizabeth and Chen, Han, The Federal Reserve's Tools for Policy Normalization in a Preferred Habitat Model of Financial Markets (October 7, 2014). FEDS Working Paper No. 2014-83. Available at SSRN: https://ssrn.com/abstract=2520159

James A. Clouse

Board of Governors of the Federal Reserve System - Monetary and Financial Market Analysis Section ( email )

20th and C Streets, NW
Washington, DC 20551
United States

Jane E. Ihrig

Federal Reserve Board - International Financial Transactions ( email )

20th and C Streets, NW
Washington, DC 20551
United States
202-452-3372 (Phone)
202-736-5638 (Fax)

Elizabeth Klee

Board of Governors of the Federal Reserve System ( email )

20th and Constitution Ave NW
Washington, DC 20551
United States

Han Chen (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of New York ( email )

33 Liberty Street
New York, NY 10045
United States

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