Question

Write a summary of Selgin's "A Monetary Policy Primer, Part 1: Money." Quote or paraphrase

Answer 1

Ans- The object of monetary policy is the responsible management of an economy's money supply. Experts do generally agree in treating "money" as a name for anything that serves as a generally-accepted means of payment. The rub resides in deciding where to draw a line between what is and what isn't "generally accepted." To make matters worse, financial innovation is constantly altering the degree to which various financial assets qualify as money, generally by allowing more and more types of assets to do so. Hence the difficulty of saying just how much money a nation possesses at any time, let alone how its money stock is changing. Hence the futility of trying to conduct monetary policy by simply tracking and regulating any particular money measure.

For all these reasons economists and monetary policymakers have tended for some time now to think and speak of monetary policy as if it weren't about "money" at all. Instead, they've gotten into the habit of treating the monetary policy as a matter of regulating, not the supply of means of payment, but interest rates. We all know what interest rates are, after all; and we can all easily reach an agreement concerning whether this or that interest rate is rising, falling, or staying put.

Although central banks certainly can influence interest rates, they typically do so, not directly except in the case of the rates they themselves charge in making loans or apply to bank reserves, but indirectly. The main thing that central banks directly control is the size and makeup of their own balance sheets, which they adjust by buying or selling assets.  

Firstly- to pay for the purchases, it would wire funds to the dealers' bank accounts, thereby adding to the total quantity of bank reserves. Secondly, the greater availability of bank reserves would, in turn, improve the terms upon which banks with end-of-the-day reserve shortages could borrow reserves from other banks. The "federal funds rate," which is the average ("effective") rate that financial institutions pay to borrow reserves from one another overnight, and the rate that the Fed has traditionally "targeted," would, therefore, decline, other things being equal.

Because the Fed's liabilities consist either of the deposit balances kept with it by other banks and by the central government the only other entity that banks with the Fed, or of circulating currency, and because commercial banks' holdings of currency and central-bank reserve credits make up the cash reserves upon which their own ability to service deposits of various kinds rests, when the Fed increases the size of its own balance sheet, it necessarily increases the total quantity of money, either indirectly, by increasing the number of cash reserves available to other money-producing institutions, or directly, by placing more currency into circulation.

If the money-supply effects of central bank actions aren't always predictable, the interest rate effects are still less so. Interest rates, excepting those directly administered by central banks themselves, are market rates, the levels of which depend on both the supply of and the demand for financial assets. The federal funds rate, for example, depends on both the supply of "federal funds" (meaning banks' reserve balances at the Fed) and the demand for overnight loans of the same. The Fed has considerable control over the supply of bank reserves; but while it can also influence banks' willingness to hold reserves, that influence falls well short of anything like "control."

It's, therefore, able to hit its announced federal funds target only imperfectly, if at all. Finally, even though the Fed may, for example, lower the federal funds rate by adding to banks' reserve balances, if the real demand for reserves hasn't changed, it can do so only temporarily. That's so because the new reserves it creates will sponsor a corresponding increase in bank lending, which will, in turn, lead to an increase in both the number of bank deposits and the nominal demand for (borrowed as well as total) bank reserves. As banks' demand for reserves rises, the federal funds rate, which may initially have fallen, will return to its original level.