Working Paper: NBER ID: w25911
Authors: James D. Hamilton
Abstract: The Federal Reserve characterizes its current policy decisions in terms of targets for the fed funds rate and the size of its balance sheet. The fed funds rate today is essentially an administered rate that is heavily influenced by regulatory arbitrage and divorced from its traditional role as a signal of liquidity in the banking system. The size of the Fed’s balance sheet is at best a very blunt instrument for influencing interest rates. In this paper I compare the current operating system with the historical U.S. system and the procedures of other central banks. I then examine strategies for transitioning from the current system to one that would give the Federal Reserve more accurate tools with which to achieve its strategic objective of influencing inflation and output.
Keywords: monetary policy; federal reserve; interest rates; quantitative easing; policy instruments
JEL Codes: E4; E5
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Federal funds rate (E43) | effectiveness as a policy instrument (F68) |
| Regulatory changes (G18) | effectiveness of the funds rate as a policy instrument (E52) |
| Fed's balance sheet size (E52) | influence on interest rates (E43) |
| Large-scale asset purchases (QE) (E44) | long-term interest rates (E43) |
| Corridor system (ECB) (F55) | management of short-term interest rates (E43) |
| Reverse repo rate (E43) | floor for short-term interest rates (E43) |