[Joseph_E._Stiglitz,_Carl_E._Walsh]_Economics(Bookos.org) (1)

9
8
7
INTEREST RATES (%)
6
5
4
3
2
Target
Federal funds
rate
1
0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000
2001 2002 2003 2004
Figure 32.1
THE FED’S TARGET AND THE
FUNDS RATE
Though the actual federal funds rate is determined by supply and demand, it closely
follows the target set by the Fed.
SOURCE: Federal Reserve Board.
sale of a government security and an agreement to repurchase it at a future date—
perhaps the next day.)
The last major activity of the day is a 3:15 P.M. telephone meeting with representatives
of the government security market dealer firms. The interchange of information
helps keep the Trading Desk informed of the dealers’ perceptions of
developments in the financial markets. 1
The Fed’s Target for the Funds Rate The activities of the Trading Desk
are designed to affect the level of the federal funds rate, which plays a critical role
in the economy precisely because it is the rate that the Federal Reserve can most
directly control. At each FOMC meeting, the members of the committee must decide
whether the federal funds rate should remain unchanged, be raised, or be lowered.
Though the FOMC decides on its target for the funds rate, the rate itself is determined
by the interplay of demand and supply in the market for federal funds. Thus
the federal funds rate can diverge from the Fed’s target—but by influencing supply
in the federal funds market every day through its open market operations, the Fed
can keep these divergences very small, as Figure 32.1 shows.
To grasp what the Fed does and how it affects the economy, we must examine
the factors that determine demand and supply in the federal funds market. We can
1 For an excellent and detailed discussion of how monetary policy is conducted in the United States, see
Ann-Marie Meulendyke, U.S. Monetary Policy and Financial Markets (New York: Federal Reserve Bank of
New York, 1998).
THE FEDERAL FUNDS MARKET ∂ 717