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Closing the Monetary Policy Curriculum Gap: A Primer for Educators Making the Transition to Teaching the Fed's Ample-Reserves Framework, Accessible Data
Figure 1. Transmission of Monetary Policy
Figure 1 is a flow diagram with 5 boxes. The left box says “FOMC Sets Federal Funds Target Range.” There is an arrow from this box to the next box. The arrow says “Implementation Regime.” The second box says “Affects current and expected short-term interest rates.” There is an arrow from this box to the next box. The third box says “Affects longer-term interest rates and overall financial conditions.” There is an arrow from this box to the next box. The fourth box says “Influences consumers’ and producers’ spending decisions. There is an arrow from this box to the next box. The final box says “Progress made toward maximum employment and stable prices.”
Figure 2. Monetary Policy with Limited Reserves
Figure 2 illustrates a demand and supply curve. The y axis denotes the level of interest rates; the x axis denotes the quantity of reserves.
The demand curve is a line drawn downward sloping. The y intercept is at a point labeled “discount rate” at a random, positive value above zero. The line then moves down steeply, so that one portion of the curve is steeply downward sloping. The line eventually levels off and becomes nearly flat (that is, has a slope of zero), so that a second portion of the curve is entirely nearly flat. The point that the curve levels off is around zero on the y axis.
The supply curve is a vertical line. It intersects the demand curve on its steep portion. The intersection of the two curves has a y-axis value labeled “FFR.”
Figure 3. Monetary Policy with Ample Reserves
Figure 3 illustrates a demand and supply curve. The y axis denotes the level of interest rates; the x axis denotes the quantity of reserves.
The demand curve is a line drawn downward sloping. The y intercept is at a point labeled “discount rate” at a random, positive value above zero. The line then moves down steeply, so that one portion of the curve is steeply downward sloping. The line eventually levels off and becomes nearly flat (that is, has a slope of zero), so that a second portion of the curve is entirely nearly flat. The point that the curve levels off is between the two points labeled “IOR rate” and “ON RRP rate,” which are below the “discount rate” but above zero.
The supply curve is a vertical line. It intersects the demand curve on its flat portion. The intersection of the two curves has a y-axis value labeled “FFR.”
Figure 4. Example of Bank’s Investment Options
This figure shows three options for a bank to invest its cash. Option 1, on the top of the figure, is “Deposit funds at the Fed” and “Earn IOR.” Option 2, in the middle of the figure, is “Loan to a bank” and “Earn FFR.” Option 3, on the bottom of the figure, is “invest in Treasury bills” and “Earn bill rate.”
Figure 5. Illustration of an ON RRP Transaction
This figure shows the two legs of a reverse repurchase transaction.
Leg 1, on the left, notes reserve balances fall. The set of transactions illustrated are (1) Fed sells security to counterparty and (2) counterparty deposits funds at the Fed.
Leg 2, on the right, notes reserve balances rise. The set of transactions illustrated are (1) Fed buys back security and (2) counterparty receives funds plus interest.
Figure 6. Comparing Diagrams: Limited Reserves and Ample Reserves
This figure has two panels. On the left is Figure 2 and on the right is Figure 3. There are two key differences between these figures. First, the demand curve on the left is flat around zero on the y axis (near the horizontal axis), while the demand curve on the right is flat above zero and lies between the “IOR” rate and “ON RRP Rate.” Second, the vertical supply curve intersects the demand curve at different points. In the left figure the intersection is on the downward sloping portion of the demand curve, while on the right it is on the flat portion of the demand curve.
Figure 7. Using Open Market Operations in the Limited Reserves Regime
This figure is a flow chart showing how the Fed’s purchase of securities gets reserves to banks. There are 4 interactions. On the left is the “Federal Reserve.” The Fed interacts with “Primary Dealers.” The arrow from the Fed to the Primary Dealer says “money,” and the arrow from the Primary Dealer to the Fed says “Bonds.” From the Primary Dealers there is an arrow to “Investors.” Then an arrow to “Banks” and finally an arrow to “Bank Reserves Increase.”
Figure 8. Expansionary Policy with Limited Reserves
There are two panels. On the left is figure 2. On the right is the illustration of how the supply curve shifts with the expansion of monetary policy, through an open market purchase of securities. This is shown by a shift in the vertical supply curve to the right. And, the demand curve’s y intercept is also lowered, as the discount rate is decreased. The supply curve now intersects the demand curve at federal funds rate that is a bit lower than originally shown in the left. The shift in the federal funds rate is shown as a move from “FFR 1” to “FFR 2.”
Figure 9. Expansionary Policy with Ample Reserves
There are two panels. The left panel is figure 3. The right panel is the illustration of how the demand curve adjusts with the expansion of monetary policy. The demand curve’s end points are lowered. The y intercept has a lower discount rate. The flat, horizontal portion of the curve is also lower because the IOR Rate and ON RRP rates are lower. Demand and supply still intersect on the flat portion of the demand curve, but it is at a lower FFR when compared to the left panel.