Question

Two systems of monetary policy implementation are the "floor" system and the "symmetric corridor" or "symmetric channel" system.

In which system would you expect to see central bank staff (such as the "Desk" at the Fed) engage more frequently in open-market operations, or would the frequency of open-market operations be the same under the two systems?

Answer 1

In both the corridor and floor approaches,the level of reserve balance is set to the minimum levels needed to execute the monetry policy effectively,i.e under both the systems banks demands for the reserve is met.One of the major functions of Fed, is agrreing on a disired policy rate, once that is decided by the federal open market committee,it takes the choice of putting the plan in motion using both the systems,

The Fed influences the amount of reserves available to the commercial banking system by open market operations.This is the process by which the Fed can buy or sell securities in the market to increase or decrease reserve balances,When the Fed buy scurities it increases liquidity by increasing reserves and when it sells reserves decrease and liquidity is withdrawn.

Under the corridor system.the discount rate is above the target interest rate and the interest on excess reserve is set below the target rate.This is the corridor of the market interest rate.i.e.interest rate in the market is regulated by changing the supply of reserve balances.After 2008, the Fed switched to the floor system under which the interest on excess reserve is set close to the target rate.Open market operations are also responsible for supplying the appropriate amount of reserve balance to achieve the desired market rate.