Question

Suppose on any given day there is an excess demand of reserves in the federal funds market. What would be the appropriate action for the Fed to take to keep the federal funds rate at its current level? Would this action be an example of conventional or unconventional monetary policy, and would it be considered defensive or dynamic?

Answer 1

There is an excess demand for reserves in the federal funds market, this essentially means that banks are borrowing more because the federal rates are lower and they are able to afford the interest rates, however excess demand will lead to increase in the federal funds interest rates.

Thus the appropriate action for the Fed would be to undertake open market purchase operations of bonds so that the money is spent and the federal funds rate stays at the current level as the money is spent and banks can't borrow anymore.

This is an example of conventional monetary policy as the central bank does this often to adjust the supply of central bank money to set overnight target rates. Unconventional measures are used in rare circumstances.

Defensive is when short term strategies are used whereas dynamic are groundbreaking one's which are for a longer duration and intended to permanently change the monetary base. Thus this is defensive.