United States[$]

Institutional framework

The Federal Reserve Act establishes that the Board of Governors and the FOMC should conduct monetary policy "so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates." This statutory mandate ties monetary policy to the broader goal of fostering a productive and stable US economy.

The Federal Reserve's framework for monetary policy implementation features a short-term interest rate target as its key policy measure to communicate the FOMC's policy stance and an operating regime with ample reserves to implement this policy stance. The Federal Reserve uses a set of administered rates set by the Board of Governors and the FOMC, as well as market operations directed by the FOMC and conducted by the Open Market Trading Desk at the Federal Reserve Bank of New York to achieve its monetary policy objective. These tools help promote money market rate conditions consistent with the policy rate target. The FOMC can also alter the size and composition of its balance sheet and provide forward guidance about the path of the policy rate as additional policy measures to achieve its objectives.

Key features of the monetary policy implementation framework

The tools used by the Federal Reserve for policy implementation enable the central bank to maintain short-term interest rate control in an environment of ample reserve balances in the banking system. 1 The FOMC's key policy rate is a target range for the federal funds rate. The federal funds rate is the rate at which depository institutions and other eligible entities conduct overnight unsecured transactions in central bank balances. The width of the target range for the federal funds rate is 25 basis points. 2 The Federal Reserve sets administered rates - the interest rates paid on required and excess reserves that a bank holds at the Federal Reserve, supplemented by ON RRPs offered at a specified rate to a wide range of active nonbank lenders in addition to banks - as a means to move the federal funds rate into the target range and to maintain it in that range without actively adjusting the supply of reserve balances. 3 The interest on excess reserves (IOER) rate is the primary tool used to influence overnight interest rates. If a bank can earn interest on the reserve balances it holds at the central bank, then given the safety and convenience of this investment, little incentive exists for the bank to lend to private sector counterparties at a rate lower than that offered by the central bank. Further, if the bank can acquire funds in the wholesale market at rates below the rate paid on reserves, competition for these funds to earn an arbitrage profit would suggest that banks will bid up these rates to a level close to the interest rate on reserves.

Both IOER and the ON RRP offering rates have been helpful to guide the levels of the federal funds and other money market rates. In particular, several years back when market repo rates were soft, the ON RRP offering rate provided a soft floor to repo rates, which in turn helped maintain federal funds rates in the target range. More recently, when market repo rates moved above the FOMC's target range and put upward pressure on federal funds rates, the Federal Reserve made a few technical adjustments to lower the IOER rate, which lowered the federal funds rate within the target range.

The Federal Reserve also maintains the discount window, which is a secured lending facility designed to provide liquidity to commercial banks and other depository institutions. This facility acts as a ceiling for short-term interest rates: if the cost of obtaining reserve balances in the market becomes relatively expensive, then banks borrow funds from the discount window to manage reserve balances. In this way, the rate on discount window loans helps put a ceiling on the private market rate for reserve balances.

Unconventional monetary policy measures

In response to the financial crisis, the FOMC took a series of unconventional monetary policy measures. In particular, the FOMC conducted large-scale asset purchase programs (LSAPs) in the Treasury, agency debt, and agency MBS markets, which were designed to ease financial conditions and support the US housing market, and led to a significantly larger central bank balance sheet.

In October 2017, the FOMC initiated a program to gradually reduce the size of the Federal Reserve's securities holdings from elevated levels. At its July 2019 meeting, the FOMC noted that it would conclude the reduction of its aggregate securities holdings in the System Open Market Account in August 2019. However, the FOMC has affirmed - most recently following the January 2019 FOMC meeting - that the Committee would be prepared to use its full range of tools, including altering the size and composition of its balance sheet, if future economic conditions were to warrant a more accommodative monetary policy than can be achieved solely by reducing the federal funds rate.