THE EVOLUTION OF THE FEDERAL RESERVE MONETARY POLICY GROUNDS IN THE LATE XX – EARLY XXI CENTURIES

Abstract

The full-scale financial crisis in 2008–2009 years caused serious challenges for governments and central banks responsible for general economic policies and especially monetary policy measures. The Federal Reserve System of USA (or Fed) turned out to be among the most successful players who reacted adequately to the crisis. That’s why the evolution of monetary policy approaches in the USA during the last decades is of great theoretical and practical interest. The grounds of monetary policy in the USA can be studied within the analysis of the federal funds market, where the interaction of demand for and supply of reserves determines the federal funds rate. Since 1989 Federal Reserve used federal funds rate targeting, keeping this rate lower than the discount rate. In those times the main monetary tools of Fed were represented by open market operations, required reserves changes and discount rate changes. In January 2003 the role of discount rate had changed substantially. Since then Federal Reserve has kept the discount rate higher than the target for federal funds rate and treats it as a tool for limiting federal funds rate fluctuations and means of liquidity providing. The next important change was dated by October 2008, when the Fed decided to pay interest on reserve balances held by banks. The rate on reserves became an efficient low bound for the federal funds rate. By this Federal Reserve to a great extent copied the channel/corridor system for its basic short-term interest rate used earlier in Canada and some other countries. Under such conditions, the role of reserve requirements declined as the central bank received alternative means for controlling federal funds rate fluctuations. Summarizing the dynamics of monetary tools application by Federal Reserve we can conclude that during the last 30 years the situation has changed dramatically. Only open market operations are still used as a primary tool of monetary policy in the USA, because of their full control by Fed, flexibility, and quickness in implementation. Changes in reserve requirements are no used more. The role of discount rate evolved and together with the newly created tool – the interest rate on reserves paid by Federal Reserve – it is used today to determine the bounds for federal funds rate fluctuations. From the other hand, discount lending enables the Fed to perform its role of lender of last resort efficiently. During the year 2008 as crisis exploded, Federal Reserve used all the potential for interest rate decrease and faced the so-called zero-lower-bound problem. As a result, some nonconventional monetary policy tools such as quantitative easing (massive asset purchase programs) and forward guidance (management of economic agents’ expectations using commitments to future monetary policy actions) were proposed. Such measures turned out to became efficient enough to stabilize the economy of the United States. Key words: monetary policy, Federal Reserve, federal funds market, federal funds rate, open market operations, discount rate, reserve requirements, the rate on reserves.