Expectations, Open Market Operations, and Changes in the Federal Funds Rate

John B. Taylor

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Monetary Policy and Economic Impact Banking stability, regulation, efficiency Economic theories and models

Abstract

Abstract: This paper develops a simple linear stochastic rational expectations model of the federal funds market. The model includes both a trading desk reaction function and a demand for Fed balances. The demand for Fed balances depends in part on expectations of the future federal funds rate. Starting with a detailed description of trading in this overnight market, the paper pinpoints key features of the market that are important for explaining why the actual federal funds rate moves in response to target rate changes with little or no open market operations. The model incorporates those features and other recent policy changes. Simulations of the model indicate that it can explain the timing of the movements of the federal funds rate seen in the market.

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References

1997Systematic Monetary Policy and the Effects of Oil Price Shocks 1996The Daily Market for Federal Funds 1995Federal Reserve interest rate targeting, rational expectations, and the term structure 1995Federal Reserve interest rate targeting, rational expectations, and the term structure 1968COMMERCIAL BANK RESERVE MANAGEMENT IN A STOCHASTIC MODEL: IMPLICATIONS FOR MONETARY POLICY 1976The Observational Equivalence of Natural and Unnatural Rate Theories of Macroeconomics 2000Monetary Policy in a World Without Money 2000Open mouth operations

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