The Federal Reserve System (FED) has price stability, high employment, economic growth, financial market and institution stability, interest rate stability, and foreign-exchange market stability as its monetary policy goals (Mishkin, 2007). The main challenges the FED faces in achieving these goals include the diverse effect that achieving one goal can have on another one, the inability of FED’s tool to achieve all its monetary policy goals directly, and the timing difficulties in achieving those goals (Mishkin, 2007). The first challenge might be overcome through either putting FED’s goals by the accessible means of their achievement or through the determination of the most important goal at the moment. The second challenge can be faced by the modified tools designed specifically for achieving the FED’s goals. The third challenge demands restructuring the FED’s work to enable it to achieve monetary policy goals as soon as they are established.
Open market operations (OMO) constitute one of the tools the FED uses to achieve its monetary policy goals. However, OMO affects the banking system of the country in three major ways as the FED buys and sells securities issued by the banks (Mishkin, 2007). The first way the FED affects the banking system is the impact OMO by the FED has on the growth of banking deposits that either grow or decrease depending on interest rates established by the FED. The second effect of the FED’s OMO is the very level of interest rates that banks have to attach to their loans and borrowing based on the FED’s instructions (Kohn, 2008). The third way the FED affects the banking system lies in the fact that banks are thus controlled by the FED that buys or cells their securities and can dictate their will to the banks around the country (AmosWeb, 2009).
Reserve requirements state that every bank or any other depository institution in the United States must hold a certain amount of its funds, whether it is money, securities, checking accounts, etc., in the form of the vault cash and deposits of the Federal Reserve (Mishkin, 2007). By this requirement, the FED achieves control over the deposits and assets of banks and depository institutions and dictates the interest rates these institutions must establish. Therefore, the change in the reserve requirements results in the change of the banks’ assets as the sum changes, which they have to place with the FED. Accordingly, the fewer assets banks have, the higher interest rate they can establish for the loans they give.
FED uses the establishment of its intermediate and operating targets to help in facing the challenges met by the FED in achieving its monetary policy goals (Mishkin, 2007). However, FED cannot set the intermediate targets in terms of monetary aggregates and interest rates because both these notions are rather fluctuating and subjected to numerous, often unpredictable, changes. As far as the intermediate targets must be controllable and measurable, monetary aggregates and interest rates do not fit for the role of intermediate targets (Mishkin, 2007). The operational targets, on the other hand, can be established based on both monetary aggregates and interest rates as they are dynamic targets aimed at monitoring economic development.
Works Cited
- AmosWeb. “Open Market Operations.” 2009. Amosweb. Web.
- Kohn, Donald. “Condition of the US Banking System.” Testimony. 2008. Board of Governors of the FED.
- Mishkin, F.S. Money and Banking. Custom edition (2nd ed) Boston: Addison – Wesley, 2007.