Banking System Diffusion of Open Market Operations

Abstract

The spirited discussion and the innovative research of the past decade contributed greatly to our current understanding of the channels and effects of monetary policy. The result has been a more eclectic stance by the monetary authorities on topics such as interest rates, the quantity of money, and lags in the impact of monetary policy. During this same period, on a somewhat more operational level, considerable debate was occurring on the relative merits of open market operations vs. reserve requirement changes [1;2;6;8;12]. The chief arguments in favor of open market operations are well known. Such operations are flexible, easily applied, and readily fine tuned. While reserve requirement changes have none of these qualities, they have one feature which open market operations do not: the results of reserve requirement changes are synchronously felt over all components of the banking system, in all parts of the nation. Thus, one objection which is raised against the use of open market operations has to do with the condition that open market operations are conducted in the central money markets. As compared to the results of a change in reserve requirements, open market operations may potentially lead to a disproportionate concentration of reserves in the central money market banks. Supporters of open market operations suggest that, while this circumstance of concentrated impacts may have been the case at one time, recent money market developments and innovations (such as expanded use of the Federal Funds market, development of Certificates of Deposit, technical advances in information transmission, and expanded participation by formally inactive components of the banking system) have tended to even the impact of open market operations, so that such operations are now felt more uniformly throughout the banking system.' The present study attempts to determine whether open market operations have become a more effective instrument for con-