Monetary Policy in a Model with a Federal Funds Market: Fixed versus Flexible Deposit Rates

Abstract

This paper examines the comparative static effects of various monetary policy instruments under the assumption of a market determined interest rate on demand deposits, and, alternatively, for the case of an exogenously fixed demand deposit rate. In both cases monetary policy effects are analyzed where the monetary policy operating target is either the Federal funds rate or a reserve aggregate. The aim of the paper is to assess the differences in monetary policy effects, for each operating procedure, between the flexible and fixed deposit rate cases. We extend previous analyses of this subject by incorporating an explicit Federal funds market in our model and providing a detailed analysis of monetary policy with a Federal funds rate operating target with both a flexible and a fixed deposit rate. Additionally we consider the differences in the role of secondary monetary policy instruments, such as the discount rate and the required reserve ratio, in the different regimes. Finally, the paper considers the implications of flexibility of the deposit rate for the feasibility of the current monetary policy strategy of using a short-run operating target (either the Federal funds rate or a reserve aggregate) to attain target