A Short-Term Model of the Fed'S Portfolio Choice

Abstract

What would happen if the Federal Reserve were to change the assets in its portfolio? Suppose that instead of using open-market operations in Treasury securities to increase the monetary base, the Fed were to engage in open-market operations in private securities or to use discount loans via a mechanism that allowed banks to borrow as much as they would like at a fixed discount rate. The analysis in this paper shows the impact on the economy in a static general-equilibrium model. This model follows Santomero (1983), adapted to evaluate a change in the Fed's portfolio and how that affects the economy's general equilibrium at a point in time. The nature of the exercise done here is completely static in nature and does not evaluate the economy's response to a disappearance of government debt, analysis of which would require a more complete model that's dynamic in nature and incorporates real effects. The present model focuses on the more narrow issue of the direction of portfolio changes with no real-side economic effects. But the model is general equilibrium in nature and thus performs a reasonable comparative-static exercise. In what follows, the author first describes the model in Section I. Next, the author models a situation in which the Fed changes its portfolio in such a way as to keep the interest rate on deposits from changing (Section II). Section III generates results under a special set of assumptions that lock most interest rates together. Section IV attempts to generalize the results to a situation in which the monetary base is unchanged. Section V summarizes the results.