Accounting and the potency of open market operations

Abstract

Through a mathematical programming setup, reserve accounting is shown to be auxiliary to accomplishing monetary policy operating objectives. This article outlines a theoretical way of comparing the potency of open market operations under different reserve accounting procedures. It is shown that if the interest sensitivity of reservable liabilities is greater than the interest sensitivity of reserves, then lagged reserve accounting makes Federal Reserve open market purchases and ‘sells’ of securities more powerful in affecting the federal funds rate.

Notes

¹ The change from the contemporaneous reserve accounting method to a lagged reserve accounting method; the Open Market Desk at the New York Federal Reserve has altered its intervention practices to become more responsive to day-to-day movements in the supply of and demand for reserves; banks adopting better information systems and procedures to track and anticipate payment flows; the Federal Open Market Committee has a policy (effective February 1994) to announce changes in the target funds rate immediately (though Hilton states that this has not had a noticeable affect on rate volatility due to the market's ability to read the Open Market Desk's signals intended to communicate the stance of policy); low target rates have limited the potential for reductions in the target rate, which has lifted the level of total requirements banks hold with the Federal Reserve because of the increased deposits customers have placed in demand deposit accounts.

² See FRBSF Economic Letter, Number 2004–01, 16 January 2004, ‘US Monetary Policy: An Introduction’ for an easy introduction.