Macroeconomics

‭K. Tools of Central Bank Policy‬ ‭Central‬ ‭banks‬ ‭use‬ ‭monetary‬ ‭policy‬ ‭tools‬ ‭to‬ ‭influence‬ ‭money‬ ‭supply‬ ‭and‬ ‭interest‬ ‭rates‬ ‭to‬ ‭achieve‬ ‭macroeconomic objectives. The tools of monetary policy include the following:‬

‭1.‬ ‭Open market operations (OMOs)‬

‭2.‬ ‭The‬‭discount‬‭rate‬‭and‬‭other‬‭administered‬‭interest‬‭rates‬‭(e.g.,‬‭interest‬‭on‬‭reserves‬‭and‬‭the‬‭policy‬ ‭rate)‬

‭3.‬ ‭The required reserve ratio (rr)‬

‭However,‬‭the‬‭tools‬‭used‬‭and‬‭the‬‭way‬‭in‬‭which‬‭they‬‭are‬‭implemented‬‭differ‬‭between‬‭economies‬‭that‬‭have‬ ‭limited reserves and economies that have ample reserves in their banking system.‬ ‭Before‬ ‭we‬ ‭explain‬ ‭each‬ ‭of‬ ‭these‬ ‭tools,‬ ‭let’s‬ ‭understand‬ ‭the‬ ‭difference‬ ‭between‬ ‭limited‬ ‭and‬ ‭ample‬ ‭reserves banking systems.‬ ‭Limited vs. Ample Reserves Banking Systems‬ ‭Before‬ ‭the‬ ‭2008‬ ‭fnancial‬‭crisis‬‭that‬‭originated‬‭in‬‭the‬‭U.S.,‬ ‭commercial‬‭banks‬‭held‬‭very‬‭few‬‭reserves‬ ‭with‬‭the‬‭central‬‭bank‬‭and‬‭instead‬‭lent‬‭the‬‭money‬‭to‬‭customers‬‭or‬‭other‬‭banks.‬‭This‬‭system‬‭is‬‭referred‬‭to‬ ‭as‬ ‭a‬ ‭banking‬ ‭system‬ ‭with‬ ‭limited‬ ‭reserves‬ ‭,‬ ‭and‬ ‭it‬ ‭has‬ ‭a‬ ‭signifcant‬ ‭impact‬ ‭on‬ ‭interest‬ ‭rates‬ ‭when‬ ‭there is a small change in the money supply‬ ‭.‬ ‭After‬ ‭2008,‬ ‭commercial‬ ‭banks‬ ‭began‬ ‭holding‬ ‭signifcantly‬ ‭larger‬ ‭(ample)‬ ‭reserves‬ ‭with‬‭the‬‭central‬ ‭bank‬ ‭due‬ ‭to‬ ‭stricter‬ ‭regulations‬ ‭and‬ ‭the‬ ‭introduction‬ ‭of‬ ‭interest‬ ‭payments‬ ‭on‬ ‭those‬ ‭reserves.‬ ‭This‬ ‭is‬ ‭known‬‭as‬ ‭a‬‭banking‬‭system‬‭with‬‭ample‬‭reserves‬ ‭in‬‭which‬‭commercial‬‭banks‬ ‭deposit‬‭their‬‭excess‬‭funds‬ ‭with‬‭the‬‭Fed‬‭and‬‭earn‬‭a‬‭guaranteed‬‭interest‬ ‭,‬‭known‬‭as‬‭the‬ ‭Interest‬‭on‬‭Reserves‬‭(IOR)‬ ‭.‬‭In‬‭this‬‭system,‬ ‭a change in money supply has no signifcant impact on the interest rate.‬

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