ECON-002 Lecture Notes - Lecture 18: Federal Funds Rate, Janet Yellen, Bank Reserves

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5 Jun 2017
March 28th, 2017
(Part 2 after midterm 2)
Money Supply in the Short Run
1. conventional monetary policy
2. unconventional monetary policy
Janet Yellen (FOMC chair) Video (very conventional):
Main Takeaways:
-There’s more than one interest rate
-when we were thinking about the long run, it was not important to distinguish among
interest rates; there was “the” interest rate
-in the short run, we have to make distinctions
-EX: effective federal funds rate, 10-year Treasury Constant Maturity Rate, 3-Month
Treasury Bill: Secondary Market Rate, 30-Year Fixed Rate Mortgage Average in the US,
1-Year Treasury Constant Maturity Rate, etc.
-The interest rate that the Fed is interested in is the federal funds rate
-at the end of each day, banks with extra reserves lend to banks with insufficient reserves.
This activity is called the federal funds market
-the federal funds rate is the interest are that banks charge for this lending
-it’s a really short term interest rate because it is for an over-night loan
-supply of bank reserves and demand for bank reserves determine the equilibrium federal
funds rate, aka the effective federal funds rate
-If there are a lot of banks that want to lend, and there is a huge increase in lending, the
federal funds rate has to fall. Conversely, If there weren’t enough reserves in the bank,
then the federal funds rate will rise.
-The Fed does not directly control the federal funds rate
-However, the Fed DOES have a way of influencing what the amount of reserves are, so they
have a degree of influence over the federal funds rate
-Open Market Operations (OMOs)!!!!!
-Purchase and Sale (OMP and OMS)
-An Open Market Sale takes reserves out of the system, making the federal funds
rate rise
-An Open Market Purchase, on the flip side, puts reserves into the system, making
the federal funds rate fall
-The Fed has a target for the federal funds range
-The Fed is really good at conduction the exact Open Mark Operation that it needs for the
effective federal funds rate to be close to the federal funds rate target
-Fed goals: keep inflation stable, keep unemployment from rising, per mandate under
Humphrey-Hawkins (1978)
-Changes in the federal funds rate lead to changes in the longer-term interest rates that fuel
macro activity
-Closer connection to short-term rates than to long-term rates
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