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

equilibrium funds rate rises. If the Fed wishes to prevent the funds rate
from changing, it needs to engage in an open market purchase to increase
the total reserve supply.
These shifts in the reserve demand curve illustrate another important
consequence of a monetary policy that targets the funds rate. The
rightward shift of the reserve demand curve shown in Figure 32.4 led
to an equal shift in reserve supply to keep the funds rate from changing.
While the funds rate remained constant, the quantity of reserves
rose, from TR 0 to TR 1 . Through the money multiplier process discussed
in Chapter 28, this rise in reserves will increase the supply of money.
When monetary policy is implemented through control of the federal
funds rate, shifts in the quantity of reserves demand are accommodated
automatically. If banks’ demand for reserves at each federal funds
rate were to increase, the Fed would automatically allow the supply of
reserves to rise so that the funds rate would not be affected.
FEDERAL FUNDS RATE (i)
i 1
i 0
TR 0
TR 1
RESERVES (TR )
Initial
reserve
demand
New
reserve
demand
Wrap-Up
THE FEDERAL FUNDS MARKET
1. The federal funds rate is determined by supply and demand in
the federal funds market.
2. The Fed is able to keep the funds rate equal to the target set by
the FOMC by using open market operations to control the supply
of total reserves.
Figure 32.4
THE EFFECT OF AN INCREASE IN THE
QUANTITY OF RESERVES DEMANDED
Suppose the demand curve for reserves shifts rightward.
If the Fed leaves the stock of nonborrowed reserves
unchanged, the funds rate rises to i 1 , where reserve
demand and reserve supply are again equal. If the Fed
wishes to keep the funds rate at i 0 , it increases nonborrowed
reserves in order to shift the supply schedule to
the right by an amount equal to the shift in demand.
Total reserves rise from TR 0 to TR 1 .
Monetary Policy Operating
Procedures
The actual manner in which a central bank implements monetary policy is often
called the monetary authority’s operating procedures. In the case of the Fed, the
federal funds rate is the key interest rate used to implement monetary policy. Its
policy goals and assessment of the economy led the FOMC to set a target for the
funds rate. The Trading Desk at the Federal Reserve Bank of New York conducts
the actual open market operations required to keep the funds rate equal to the target
established by the FOMC. Implementing monetary policy in this fashion is often
called an interest rate operating procedure.
An interest rate procedure is not the only way monetary policy can be implemented,
and over the course of the past twenty-five years, the Fed has changed its
operating procedures several times. The main alternative to an interest rate procedure
is a money supply operating procedure that focuses on controlling a quantity—
either a reserve quantity such as total reserves or a monetary aggregate such as
MONETARY POLICY OPERATING PROCEDURES ∂ 721