Monetary Policy 101: A Primer on the Fed's Changing Approach to Policy Implementation

FEDS Working Paper No. 2015-047

http://dx.doi.org/10.17016/FEDS.2015.047

30 Pages Posted: 9 Jul 2015

See all articles by Jane E. Ihrig

Jane E. Ihrig

Federal Reserve Board - International Financial Transactions

Ellen E. Meade

Federal Reserve Board

Gretchen C. Weinbach

Federal Reserve Board

Date Written: June 30, 2015

Abstract

The Federal Reserve conducts monetary policy in order to achieve its statutory mandate of maximum employment, stable prices, and moderate long-term interest rates as prescribed by the Congress and laid out in the Federal Reserve Act. For many years prior to the financial crisis, the FOMC set a target for the federal funds rate and achieved that target through purchases and sales of securities in the open market. In the aftermath of the financial crisis, with a superabundant level of reserve balances in the banking system having been created as a result of the Federal Reserve’s large scale asset purchase programs, this approach to implementing monetary policy will no longer work. This paper provides a primer on the Fed’s implementation of monetary policy. We use the standard textbook model to illustrate why the approach used by the Federal Reserve before the financial crisis to keep the federal funds rate near the FOMC’s target will not work in current circumstances, and explain the approach that the Committee intends to use instead when it decides to begin raising short-term interest rates.

Keywords: FOMC, Federal Reserve, liftoff, monetary policy implementation, monetary policy normalization, monetary policy tools

JEL Classification: E58, E52, E43

Suggested Citation

Ihrig, Jane E. and Meade, Ellen E. and Weinbach, Gretchen Cope, Monetary Policy 101: A Primer on the Fed's Changing Approach to Policy Implementation (June 30, 2015). http://dx.doi.org/10.17016/FEDS.2015.047. Available at SSRN: https://ssrn.com/abstract=2628308 or http://dx.doi.org/10.2139/ssrn.2628308

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)

Ellen E. Meade (Contact Author)

Federal Reserve Board ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Gretchen Cope Weinbach

Federal Reserve Board ( email )

United States
202-452-2841 (Phone)

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