Description
The Federal Reserve (the Fed) and its monetary policy tools have a significant
presence in economics standards, textbooks, and curricula. The Fed
has changed the way it implements monetary policy, but many of the
recent changes are not reflected in teaching resources. This special issue
of Page One Economics® is intended to provide information and teaching
guidance for educators as they transition to teaching about the new tools
of monetary policy.
Introduction
The Federal Reserve, the central bank of the United States, has a Congressional
mandate to promote maximum employment and price stability.
While those goals were articulated in 1977,2 the approach and tools used
to implement those objectives have changed over time. Before the Financial
Crisis of 2007-09, the Fed implemented monetary policy with limited
reserves in the banking system and relied on open market operations
as its key tool. Today, the Fed implements monetary policy with ample
reserves and relies on its administered rates. Interest on reserve balances
(IORB), with the associated IORB rate, is the primary tool.3 These changes
might seem subtle, but the current framework is very different from the
previous one. This article provides an overview of how policy has changed,
with useful distinctions and guidance for anyone who teaches about the
Federal Reserve and monetary policy.
Teaching Monetary Policy
The Federal Open Market Committee (FOMC) of the Federal Reserve
sets the stance (position) of monetary policy to guide employment and
prices (inflation) in the desired direction. Figure 1 shows the chain reaction
of how the stance of monetary policy is transmitted through financial
The Fed’s New Monetary Policy Tools
Jane Ihrig, Ph.D., Board of Governors of the Federal Reserve System
Scott A. Wolla, Ph.D., Federal Reserve Bank of St. Louis
GLOSSARY
Administered rate: An interest rate that is set
directly rather than being influenced by the
market forces of supply and demand.
Arbitrage: The simultaneous purchase and sale of a
good in order to profit from a difference in price.
Discount rate: The interest rate charged by the
Federal Reserve to banks for loans obtained
through the Federal Reserve’s discount window.
Discount window: Federal Reserve lending to
depository institutions to support the liquidity
and stability of the banking system and the
effective implementation of monetary policy.
Facility: A formal financial assistance program
offered by a lending institution to help a targeted
set of counterparties (those eligible to
borrow) with funding needs. The Federal Reserve
has permanent facilities (such as the discount
window) and temporary facilities (like those
implemented during the Financial Crisis of
2007-09 and the COVID-19 pandemic).
Federal funds rate (FFR): The interest rate at which
depository institutions lend reserve balances
to other depository institutions overnight.
Federal Open Market Committee (FOMC):
A Committee created by law that consists of
the seven members of the Board of Governors;
the president of the Federal Reserve Bank of
New York; and, on a rotating basis, the presidents
of four other Reserve Banks. Nonvoting Reserve
Bank presidents also participate in Committee
deliberations and discussion.
Open market operations: The buying and selling
of government securities by the Federal Reserve.
Policy rate: The interest rate that is used by a
central bank to set and communicate its monetary
policy stance (or position). In the United
States, the FOMC uses the federal funds rate as
the policy rate.
Reserves: The sum of cash that banks hold in their
vaults and the deposits they maintain with
Federal Reserve Banks (i.e., reserve balances).
Reserve requirement: The percentage of a bank’s
deposits it is required by law to hold.
U.S. Treasury securities: Bonds, notes, and other
debt instruments sold by the U.S. Treasury to
finance U.S. government operations.
PAGE ONE Economics®
Econ Primer: August 2020	 Federal Reserve Bank of St. Louis | research.stlouisfed.org
“The Federal Reserve sets two overnight interest rates: the interest rate paid
on banks’ reserve balances and the rate on our reverse repurchase agreements.
We use these two administered rates to keep a market-­determined
rate, the federal funds rate, within a target range set by the FOMC.”
—Jerome Powell, Chair of the Federal Reserve1
Monetary
POLICY
Econ Primer
markets and ultimately affects economy activity. This
article focuses on the change in the choice of the level of
reserves to supply to the banking system and the monetary
policy tools used before and after 2008 that affect the
first link in the chain: that is, how the Fed ensures that
when the FOMC sets a particular federal funds target
range (Box 1 in Figure 1) that this level is also reflected
in current and expected short-term interest rates (Box
2). Within the Fed, this change in tools reflects a change
in what they call their “implementation regime.” Here
we will talk about it as a change in the Fed’s policy
implementation framework.
As Figure 1 shows, current and expected short-term
interest rates influence long-term interest rates and overall
financial conditions (Box 3). Those rates and conditions
then influence consumers’ and producers’ spending
decisions (Box 4)—whether they spend money or save
money. Those spending decisions then affect overall
spending, investment, and production, which affect
employment and inflation (prices).
For the public, the way the Fed implements policy is generally
not evident in their everyday lives. FOMC policy
actions, however, are designed to steer the economy
toward maximum employment and stable prices. Because
monetary policy affects the economy, the way it is implemented
is important to include in textbooks, standards,
and curricula. And because policy can and has changed
faster than these materials are updated, it is important
for educators to understand the changes and adjust their
instruction to explain them.
An Overview of the Old Framework: Monetary Policy with
Limited Reserves
Prior to 2008, the Fed used a framework in which it supplied
a limited amount of reserves to the banking system.
Traditionally, total bank reserves are composed of two
types: (i) Required reserves are funds that a depository
institution must hold in reserve against specified deposits
as vault cash or deposits with Federal Reserve Banks.
(ii) Excess reserves are funds that a depository institution
holds in its account at a Federal Reserve Bank in excess
of its required reserves balance.
Banks held reserves to meet the Fed’s regulatory reserve
requirements and to ensure they had adequate funds to
meet the banking demands of their customers. Because
reserves earned no interest, banks tended to hold just a
bit more than what was needed to meet their reserve
requirements. When banks needed extra reserves to meet
their demands, they would borrow reserves in the federal
funds market. Or, if banks had excess reserves, they could
lend them in the federal funds market. In terms of market
participation, banks that lent money acted as suppliers
of reserves in the federal funds market, and banks that
borrowed money acted as demanders of reserves in the
federal funds market. This interaction between supply
and demand determined the federal funds rate (FFR),
which textbooks define as the interest rate that banks
charge each other to borrow or lend reserves in the
federal funds market.4
Importantly, the FFR is the policy rate that the FOMC
uses to set the stance of monetary policy in pursuit of
its objectives. More specifically, the Fed sets a target for
the FFR and then uses monetary policy tools (explained
Federal Reserve Bank of St. Louis | research.stlouisfed.org 2PAGE ONE Economics®: Econ Primer
Figure 1
Transmission of Monetary Policy
FOMC sets
federal funds
target range
Affects current
and expected
short-term
interest rates
Affects
longer-term
interest rates
and overall
financial
conditions
Influences
consumers’
and producers’
spending
decisions
Progress made
toward
maximum
employment and
stable prices
Implementation
regime
The FOMC’s policy stance is transmitted through financial markets to affect consumers’ and producers’ spending decisions, which ultimately
moves the economy toward the Fed’s objectives—maximum employment and stable prices. This monetary policy implementation framework
ensures that when the FOMC changes its policy stance (raises or lowers the federal funds [FFR] target range), financial markets move
in the desired direction.
below) to influence the market-determined FFR to move
toward the FFR target. That is, the Fed uses its tools to
influence the interest rate that banks charge each other in
the federal funds market to move toward the FFR target.
Figure 2 depicts the money market diagram that may be
familiar to teachers and professors. The diagram captures
the relationship between reserves and the FFR.5 The
downward-sloping demand curve represents banks’
demand for reserves. The top of the curve is capped by
the Fed’s discount rate, which acts like a ceiling for the
FFR because banks would be unlikely to borrow funds at
a higher rate than they could get at the Fed’s discount
window. The demand curve slopes down to capture the
idea that as the cost of borrowing decreases, banks are
willing to borrow more funds to increase their holdings
of reserves. The supply curve is vertical because only the
Fed can supply reserves. The intersection of the two lines
determines the FFR.
When reserves are limited (or scarce), relatively small
increases or decreases in the supply of reserves shift the
supply curve right (left) and result in a lower (higher) FFR
as follows:
•	 To raise the FFR, the Fed decreases the supply of
reserves by selling U.S. Treasury securities in the
open market.6 The decrease in reserves shifts the
supply curve left, resulting in a higher FFR.
PAGE ONE Economics®: Econ Primer Federal Reserve Bank of St. Louis | research.stlouisfed.org 3
Table 1
Limited-Reserves Framework
Tool Definition In practice
Reserve requirements
Funds that banks must
hold in cash, either in their
vaults or on deposit at a
Federal Reserve Bank.
Reserve requirements were an important tool driving demand for bank reserves.
Open market operations
The buying and selling
of government securities
by the Federal Reserve.
Open market operations were the principal tool of monetary policy. Purchases (sales)
increased (decreased) the supply of reserves, which shifted the supply of reserves left
(right), thereby influencing where supply intersected demand, and lowered (raised) the
FFR (see Figure 2). Open market operations were used daily to fine-tune the market-­
determined FFR to the FOMC’s FFR target.
Discount rate
The interest rate charged
by the Federal Reserve to
banks for loans obtained
through the Fed’s
discount window.
The discount rate is an administered rate set by the Fed. It is the interest rate charged to
banks on their loans from the Fed’s discount window, which was in place primarily for
emergency lending. The rate was set above the FFR target to help cap the interest rates
banks paid in the federal funds market; that is, banks could borrow from the Fed at this
rate instead of having to pay a higher rate. In practice, because borrowing from the
Fed tends to be perceived as a stigma, banks tended not to borrow at the discount
window. The spread between the discount rate and the FFR target tended to be held
constant because the Fed would typically adjust the discount rate at the same time
the FOMC adjusted the FFR target.
Discount rate
Supply
Demand
Reserves
FFR
Figure 2
Monetary Policy with Limited Reserves
In the limited-reserves framework, the Federal Reserve sells or buys
U.S. Treasury securities in the open market to shift the supply of
reserves left (right), which moves the FFR higher (lower). Relatively
small movements of the supply curve move the FFR.
Federal Reserve Bank of St. Louis | research.stlouisfed.org 4PAGE ONE Economics®: Econ Primer
•	 To lower the FFR, the Fed increases the supply of
reserves by buying U.S. Treasury securities in the open
market. The increase in reserves shifts the supply curve
right, resulting in a lower FFR.
The Fed’s buying and selling of U.S. Treasury securities
is referred to as open market operations, and it was the
primary tool the Fed used to adjust the FFR and move
the economy toward maximum employment and stable
prices prior to 2008. In this framework, the Fed tended
to use daily open market operations to fine-tune the location
of the supply curve and keep the FFR at the FOMC’s
target. The Fed tended to keep the spread between the
discount rate and FFR roughly constant. So, when the
FOMC raised or lowered its policy target, the Fed also
raised or lowered the discount rate.
In summary, prior to 2008, monetary policy focused on
influencing the supply of reserves in the banking system
(using daily open market operations) as a means for
adjusting the FFR. Table 1 notes how textbooks and
curricula have usually described monetary policy in a
limited-reserves framework and also notes how it worked
in practice before 2008.
How the Financial Crisis Changed Monetary Policy
In response to economic and financial conditions in 2008,
the Federal Reserve lowered the FFR target to near zero.
And, it also shifted from setting a single FFR target to
setting a FFR target range, with the upper and lower
limits of the range consistently 0.25 percentage points
apart. For example, starting in December 2008, the target
range was set at 0 to 25 basis points (i.e., 0.0 to 0.25 percent).
But even with that low range, the economy still
needed more stimulus.7 As a result, between 2008 and
2014 the Fed conducted a series of large-scale asset-­
purchase programs to lower longer-term interest rates,
ease broader financial market conditions, and thus support
economic activity and job creation.8 In particular,
the Fed purchased a sizable amount of longer-term
securities issued by the U.S. government and issued or
guaranteed by government-sponsored agencies such as
Fannie Mae and Freddie Mac. These purchases not only
increased the Fed’s level of securities holdings but also
increased the total level of reserves in the banking system
from around $15 billion in 2007 to about $2.7 trillion in
late 2014. At this point, reserves were no longer limited
but instead quite plentiful, or “ample.”
The Financial Crisis also resulted in the implementation
of new monetary policy tools. The most significant was
interest on reserve balances (IORB). Congress had given
the Fed authority to pay IORB in 2006, with a start date
of 2011. The start date was pushed up to October 2008
so the Fed could use the tool during the Financial Crisis.
IORB applies to both required reserves (IORR) and excess
reserves (IOER).
•	 IORR: Prior to the Financial Crisis, when banks held
their required reserves on deposit at Federal Reserve
Banks they received no interest compensation, which
they recognized as a lost opportunity to earn interest
elsewhere. For this reason, it was seen as regulation
that imposed an “implicit tax” on banks. IORR eliminated
the implicit tax on reserve requirements.
•	 IOER: Because banks did not receive interest on their
reserves held at the Fed, banks often minimized their
holdings of excess reserves. The Fed’s decision to start
paying IOER changed the incentives for the marginal
excess dollar in reserves. The IOER rate became a tool to
influence banks to hold more or fewer excess reserves.
For example, a higher IOER rate relative to market
(alternative) interest rates increased the incentive for
banks to hold excess reserves at the Fed. As such, IOER
gave the Fed a powerful new tool for implementing
monetary policy.
From October 2008 to March 2020, IORR and IOER were
set to the same rate. Then, effective March 26, 2020, the
Board of Governors of the Federal Reserve System
announced that it was reducing reserve requirements
to zero, making IORR effectively irrelevant.9 Finally, as of
July 29, 2021, the Federal Reserve eliminated references
to an IORR rate and to an IOER rate and replaced them
with a single rate IORB rate.
Table 2
Monetary Policy Acronyms
Federal funds rate FFR
Federal Open Market Committee FOMC
Interest on excess reserves IOER
Interest on reserve balances IORB
Interest on required reserves IORR
Overnight reverse repurchase agreement ON RRP
Federal Reserve Bank of St. Louis | research.stlouisfed.org 5PAGE ONE Economics®: Econ Primer
As the economy recovered from the Great Recession, the
Fed took steps to reduce the supply of reserves from its
peak in October 2014 of about $2.7 trillion. Over the next
few years, the Fed reduced reserves to about $1.7 trillion.
They still remained ample, however. In fact, in January
2019, the FOMC released a statement saying it would
continue to implement policy with ample reserves in
the long run.10,11
The New Framework: Monetary Policy with Ample Reserves
When there is a large quantity of reserves in the banking
system, the Federal Reserve can no longer influence the
FFR by making relatively small changes in the supply of
reserves (Figure 3). That is, because the supply curve
intersects the flat (horizontal) portion of the demand
curve, small shifts in the supply curve to the right or left
will not move the FFR higher or lower. Rather, in the
ample-­reserves framework, the Fed uses its administered
rates, which include the IORB rate and the overnight
reverse repurchase agreement (ON RRP) rate, to influence
the FFR. This section describes how this new framework
works.
Figure 3 shows the demand and supply curves in the
current ample-reserves framework. The top of the demand
curve is still influenced by the Fed’s discount rate. Now,
however, the demand curve turns flat near the Fed’s new
administered rates, which helps steer the FFR into the
FOMC’s target range. The supply curve is such that it
intersects the demand curve where it is flat. With this
“ample” level of reserves, the Fed does not need to make
daily open market operations to purchase or sell securities,
as it did in the limited-reserves framework to hit the
FFR target (because now small shifts of the supply curve
have little or no effect on the FFR rate ).
The primary tool for keeping the FFR in its target range
and driving the demand curve flat is the IORB rate.
Although banks have several short-term investment
options for their money (Figure 4), the IORB rate offers
them a safe overnight option. Because IORB makes cash
deposited at the Fed a risk-free investment option, banks
are unlikely to lend reserves in the federal funds market
Demand
Reserves
Figure 3
Monetary Policy with Ample Reserves
Discount rate
Supply
IORB rate
ON RRP rate
FFR
In the ample-reserves framework, the Federal Reserve raises (lowers)
its administered rates to move the FFR higher (lower). Small shifts
of the supply curve have little or no effect on the FFR rate.
Banks seek to earn a return on their money, and they have several
options. One is to deposit excess cash at their Federal Reserve
Bank (reserve balances) and earn interest. Another option is to
lend the excess cash out in the federal funds market and earn the
agreed-upon FFR. A third option is to invest the cash in Treasury
bills and earn the given Treasury bill rate.
Figure 4
Examples of Banks’Short-Term Investment Options
Invest in Treasury bills; earn bill rate
Deposit funds at the Fed; earn IORB rate
©AgnosticPreachersKid/CCBY-SA3.0
Loan to a bank; earn FFR
©AlexHubenov/Shutterstock
Investmentoptions
Federal Reserve Bank of St. Louis | research.stlouisfed.org 6PAGE ONE Economics®: Econ Primer
for less than the IORB rate. In other words, the IORB rate
serves as a reservation rate for banks—the lowest rate
that banks are likely willing to accept for lending out
their funds. And, if the FFR were to fall very far below
the IORB rate, banks would be likely to borrow in the
federal funds market and deposit those reserves at the
Fed, earning a profit on the difference. This is known as
arbitrage, an important aspect of the way financial
markets, and monetary policy, work. Arbitrage ensures
that the FFR does not fall much below the IORB rate.
These financial incentives (i.e., the reservation rate and
arbitrage) are such that when the Fed raises or lowers
the IORB rate, the FFR also moves up or down. As such,
the Federal Reserve can steer the FFR into the target
range set by the FOMC by adjusting the IORB rate.12 And,
because the Fed sets the IORB rate directly, IORB serves
as an effective monetary policy tool. Currently, IORB is
the primary tool used by the Fed for influencing the FFR.
However, not all institutions with reserve accounts can
earn interest on their deposits at the Federal Reserve
and not all important institutions in financial markets
are allowed to have an account at the Fed. This leaves
the possibility that important short-term rates (including
the FFR) might drop below the IORB rate. So, in 2014, the
FOMC announced that it intended to use the ON RRP
facility to help control the FFR.13 The ON RRP facility is a
form of open market operations where the Fed stands
ready to interact with many nonbank financial institutions,
such as large money market funds and government-­
sponsored enterprises.14 When one of these institutions
uses the ON RRP facility, it essentially deposits reserves
at the Fed overnight, receiving a security as collateral.
The next day the transaction is “unwound”—the Fed buys
back the security and the institution earns the ON RRP
rate (which the Fed sets) on the cash it deposited at the
Fed15 (Figure 5).
Because this is a risk-free investment option, the given
institutions will likely never be willing to lend funds for
lower than the ON RRP rate. As such, the ON RRP rate acts
as a reservation rate and institutions can use it to arbitrage
other short-term rates. Thus, the rate paid on ON RRP transactions,
which is set below the IORB rate, acts like a floor
for the FFR and serves as a supplementary policy tool.
Table 3 provides a summary of the tools used in an ample-­
reserves framework. These concepts should be covered
in textbooks and curricula. In fact, the IORB and ON RRP
rates should be the focus of policy implementation discussions,
with open market operations mentioned as a
maintenance tool. This discussion has quite a different
focus from that in the limited-reserves framework.
Leg 1
Reserve balances fall
Leg 2
Reserve balances rise
Counterparty deposits funds at the Fed
Figure 5
Illustration of an ON RRP Transaction
Financial
institution
Federal
Reserve
Financial
institution
Federal
Reserve
Fed buys back the securityFed sells security to counterparty
(with commitment to buy back)
Counterparty receives funds plus interest
BOND BOND
When using the Fed’s ON RRP facility, the counterparty interacts with the Fed in two steps. First, today (Leg 1) the counterparty deposits
funds at the Fed. Second, because this is an ON (overnight) RRP, tomorrow (Leg 2) the counterparty gets its cash back with a bit of interest.
Federal Reserve Bank of St. Louis | research.stlouisfed.org 7PAGE ONE Economics®: Econ Primer
During recent times of severe stress, the ample-reserves
framework has continued to support the implementation
of monetary policy. The Fed’s response to the COVID-19
pandemic has been similar to its response to the Financial
Crisis of 2007-09. With the ultimate goal of stimulating
the economy, it has lowered the FFR target range to 0
to 25 basis points; lowered the IORB and ON RRP rates
to near zero; and taken other, often unconventional,
actions to help markets function, support credit flows to
households and businesses, and lower longer-term interest
rates.16 The majority of the Fed’s special facilities
enabled it to buy, lend, or swap less-liquid financial assets
in return for reserves. Now, as during the Financial Crisis
of 2007-09, these actions have shifted the supply curve
in Figure 3 to the right and resulted in reserves becoming
quite abundant. Though these actions were quite quick
and substantial, implementation of monetary policy
remained smooth as the Fed continued to operate in its
existing (ample-­reserves) implementation framework.
Comparing the Ample-Reserves Framework with the LimitedReserves
Framework
The classic model for teaching monetary policy in the
classroom features a money supply and demand model.
A key difference between the limited-reserves framework
and the ample-reserves framework lies in where the
supply curve intersects the demand curve.
•	 In the limited-reserves framework (Panel A of Figure 6),
the supply curve intersects the demand curve on the
downward sloping part of the demand curve. In this
region, relatively small shifts of the supply curve to
the right (left) move the FFR rate lower (higher).
•	 In the ample-reserves framework (Panel B of Figure 6),
the supply curve intersects the demand curve on the
flat portion of the demand curve. In this region, relatively
small shifts of the supply curve have little or no
effect on the FFR rate.
Table 3
Ample-Reserves Framework
Tool Definition In practice
IORB
Interest paid on reserve
balances that banks hold
in their accounts at a
Federal Reserve Bank.
The IORB rate is an administered rate set by the Fed. Banks are unlikely to lend their
reserves in the federal funds market for less than they get paid by the Fed. As such,
IORB is an effective tool for guiding the FFR. In fact, interest on reserves is the principal
tool for moving the FFR within the target range.
ON RRP
An overnight transaction
in which the Federal
Reserve sells a security to
an eligible counterparty
and simultaneously agrees
to buy the security back
the next day.
The ON RRP rate is an administered rate set by the Fed. More types of financial institutions
can participate in the ON RRP facility than can earn IORB. Because these institutions
are unlikely to lend funds for lower than the ON RRP rate, and institutions can
arbitrage the difference between short-term rates, the FFR is unlikely to fall below the
ON RRP rate. As such, the ON RRP rate is a supplementary tool that acts like a floor for
the FFR. NOTE: The ON RRP facility is a form of open market operations.
Open market operations
The buying and selling of
government securities by
the Federal Reserve.
While daily purchases and sales are no longer used to adjust the supply of reserves and
influence the FFR, open market operations are an important tool for ensuring that
reserves remain ample.
Discount rate
The interest rate charged
by the Federal Reserve to
banks for loans obtained
through the Fed’s discount
window.
The discount rate is an administered rate set by the Fed. It is set above the FFR target
range with the intention of it serving as a ceiling for FFR transactions because banks
are unlikely to borrow at a higher rate than they can borrow from the Fed at the discount
window. The perceived stigma of borrowing from the Fed, however, generally
dampens the rate’s effectiveness as a ceiling. The spread between the discount rate
and the FFR target tends to be constant: The Fed typically adjusts the discount rate at
the same time the FOMC moves the FFR target range.
Reserve requirements
Funds that banks must
hold in cash, either in
their vaults or on deposit
at a Federal Reserve Bank.
With reserves ample, and many banks holding excess reserves, reserve requirements
remain a stated tool but are not a factor in policy implementation. In fact, as of March 26,
2020, reserve requirements have been set to zero.
Based on the supply of reserves, the Fed uses different
primary tools to steer interest rates into the desired range.
•	 The limited-reserves framework (see Panel A of Figure 6)
leans on the Federal Reserve’s use of open market
operations to make adjustments to the supply of
reserves to ensure the market FFR is at the FOMC’s FFR
target. This tool’s effect on the FFR requires students
to understand the abstract topic of how open market
operations work and then link this action back to the
demand-­supply diagram.
•	 The ample-reserves framework (see Panel B of Figure 6)
relies on the Federal Reserve’s administered rates—in
particular the IORB rate—to influence the FFR. The
linkage between the Fed’s tools and the FFR requires
an understanding of how banks can arbitrage across
investment options.
Explaining the implementation of monetary policy is often
a focus of textbooks, standards, and curricula. Discussion
of the monetary policies tools used, then, needs to differ
according to the policy framework. For example, say the
FOMC has lowered the target for the FFR rate. How does
the Fed ensure that this lower target is transmitted to
financial markets? Let’s consider the key tools used in
each framework.17
In the limited-reserves framework, the Fed would purchase
securities in the open market to influence the FFR rate to
PAGE ONE Economics®: Econ Primer Federal Reserve Bank of St. Louis | research.stlouisfed.org 8
Discount rate
Supply
Demand
Reserves
FFR
Figure 6
Comparing Diagrams: Limited Reserves and Ample Reserves
Demand
Reserves
Discount rate
Supply
IORB rate
ON RRP rate
FFR
A. Limited-reserves framework B. Ample-reserves framework
Federal
Reserve
Figure 7
The Limited-Reserves Framework
Money
Fed buys bonds
Bonds
Primary
dealers
Investors Banks Bank reserves increase
To implement expansionary policy in the pre-2008 limited-reserves framework, the New York Fed’s Open Market Trading Desk used open
market operations: It bought government securities from primary dealers to increase the level of reserves in the banking system. The
increased supply of reserves resulted in a lower FFR (see Figure 8).
move toward the new lower target. More specifically, as
shown in Figure 7, the New York Fed’s Open Market Trading
Desk would use open market operations: It would purchase
government securities from its primary dealers, who sell
these securities on behalf of their clients (investors). The
money received from the sales would then be deposited
in banks, resulting in an increase in the level of reserves in
the banking system. The increase in the level of reserves
(a rightward shift of the supply curve) would result in a
decrease in the FFR, as shown in Figure 8.
In an ample-reserves framework, the Fed would lower its
administered rates, in particular the IORB rate. This action
would lower the reservation rate for reserves, putting
downward pressure on the FFR.
Graphically, in the ample-reserves framework, as the Fed
lowers its administered rates (including the discount rate)
the endpoints of the demand curve shift down, as shown
in Figure 9. The lower discount rate pushes down the top
of the demand curve. The discount rate acts as a ceiling
for the FFR because banks (aside from the perceived
PAGE ONE Economics®: Econ Primer Federal Reserve Bank of St. Louis | research.stlouisfed.org 9
Discount rate
Supply
Demand
Reserves
FFR
Figure 8
Expansionary Policy with Limited Reserves
Discount rate
Supply
Demand
Reserves
FFR 1
FFR 2
In the limited-reserves framework, when the Federal Reserve used open market operations to increase the level of reserves in the banking
system, the vertical supply curve would shift to the right, and the new intersection of the supply and demand curves would result in a lower
FFR. The Fed also tended to lower the discount rate to keep the spread between the discount rate and the FFR target constant.
Figure 9
Expansionary Policy with Ample Reserves
Demand
Reserves
Discount rate
Supply
Demand
Reserves
Discount rate
Supply
IORB rate
ON RRP rate
FFR IORB rate
ON RRP rate
FFR
In an ample-reserves framework, when the Federal Reserve lowers its administered rates, the end points of the demand curve shift down.
The vertical supply curve is unchanged. The demand curve intersects the supply curve at a lower FFR rate. In general, the Fed tends to
lower all the administered rates by the same amount, keeping the spread between the rates constant.
Table 4
Comparing the Limited-Reserves Framework with the Ample-Reserves Framework
Limited-reserves framework Ample-reserves framework
Graphing: Where supply intersects
money demand
Supply intersects demand on the steep, downwardsloping
part of the demand curve.
Supply intersects demand on the flat part of the
demand curve.
Graphing: Changes in policy
The FFR is determined by the intersection of supply
market operations to shift the supply curve left or
right.
The FFR is determined by the intersection of supply
and demand. The Fed affects the FFR by raising or
lowering the IORB rate and the ON RRP rate to shift
the flat portion of the demand curve up or down.
Key tools
Open market operations with reserve requirements
in place.
The IORB rate supplemented by the ON RPP rate.
Supporting tool(s) Discount rate. Open market operations and the discount rate.
Key tools and actions to
implement expansionary
monetary policy
The FOMC lowers the FFR target. The Fed purchases
U.S. government securities using open market
operations to increase the supply of reserves.
The FOMC lowers the FFR target range. The Fed
lowers its administered rates (in particular the IORB
rate supplemented by the ON RRP rate).
Key tools and actions to
implement contractionary
monetary policy
The FOMC raises the FFR target. The Fed sells U.S.
Treasury securities using open market operations to
decrease the supply of reserves.
The FOMC increases the FFR target range. The Fed
raises its administered rates (in particular the IORB
rate supplemented by the ON RRP rate).
and demand. The Fed affects the FFR by using open
Notes
1 Powell, Jerome. “Data-Dependent Monetary Policy in an Evolving Economy.”
Board of Governors of the Federal Reserve System, October 8, 2019;
https://www.federalreserve.gov/newsevents/speech/powell20191008a.htm,
accessed July 1, 2020.
2 In 1977, Congress amended the Federal Reserve Act, directing the Board of
Governors of the Federal Reserve System and the Federal Open Market Committee
to “maintain long run growth of the monetary and credit aggregates commensurate
with the economy’s long run potential to increase production, so as to promote
effectively the goals of maximum employment, stable prices and moderate
long-term interest rates.”
3 Board of Governors of the Federal Reserve System. “Monetary Policy Report –
July 2018.” https://www.federalreserve.gov/monetarypolicy/2018-07-mpr-part2.htm.
4 On any given day, there are many transactions that settle at slightly different
FFRs. The effective FFR is the volume-weighted median rate of these transactions.
The effective FFR is the rate we use in the figures in this article.
5 Many textbooks link the money supply to interest rates. The inclusion of that
link dates back to the 1970s and 1980s, when measures of the money supply
exhibited fairly close relationships with important economic variables such as
nominal gross domestic product and the price level. Based partly on these relationships,
the Fed conducted monetary policy by targeting growth rates of various
measures of money. Since the mid-1990s, however, these relationships have been
quite unstable. As a result, the importance of the money supply as a guide for the
FOMC in its conduct of monetary policy has diminished and the Fed has shifted
to targeting the level of the FFR, which is directly influenced by the supply of
reserves in the banking system.
6 The term “open market” refers to the fact that the Fed doesn’t buy securities
directly from the U.S. Treasury. Instead, securities dealers compete in the open
market based on price, submitting bids or offers to the Open Market Trading Desk
of the Federal Reserve Bank of New York through an electronic auction system.
7 The Fed also implemented a number of credit and liquidity programs early on
in the Financial Crisis to support financial institutions and foster improved conditions
in financial markets. These special programs expired or were closed after
some time.
8 For a description of the Fed’s large-scale asset purchases, see Board of Governors
of the Federal Reserve System. “What Were the Federal Reserve’s Large-Scale Asset
Purchases?” FAQs; https://www.federalreserve.gov/faqs/what-were-the-federal-
reserves-large-scale-asset-purchases.htm.
9 This decision reflects the fact the Federal Reserve shifted to an ample-reserves
framework, and reserve requirements are not necessarily a tool in this framework.
10 See Board of Governors of the Federal Reserve System. “Statement Regarding
Monetary Policy Implementation and Balance Sheet Normalization.” Press release,
January 30, 2019; https://www.federalreserve.gov/newsevents/pressreleases/
monetary20190130c.htm.
11 More recently, in response to the COVID-19 pandemic, reserves have grown
substantially. By April 2020, reserves expanded and stood above $3 trillion, at a
higher level than their peak during the aftermath of the Great Recession.
12 Board of Governors of the Federal Reserve System. “Interest on Required Reserve
Balances and Excess Balances.” https://www.federalreserve.gov/monetarypolicy/
reqresbalances.htm, accessed June 10, 2020.
13 Board of Governors of the Federal Reserve System. “Overnight Reverse Repurchase
Agreement Facility.” https://www.federalreserve.gov/monetarypolicy/
overnight-reverse-repurchase-agreements.htm; accessed June 4, 2020.
14 Federal Reserve Bank of New York. “Reverse Repo Counterparties.”
https://www.newyorkfed.org/markets/rrp_counterparties; accessed June 10, 2020.
15 Board of Governors of the Federal Reserve System. “Overnight Reverse Repurchase
Agreement Facility.” https://www.federalreserve.gov/monetarypolicy/
overnight-reverse-repurchase-agreements.htm; accessed June 4, 2020.
16 A complete list of policy tools can be found at the Board of Governors of the
Federal Reserve System website:
https://www.federalreserve.gov/monetarypolicy/policytools.htm.
17 In most instances, the discount rate would be lowered (in each framework) to
keep the spread between the discount rate and the FFR constant.
Additional Resources
Ihrig, Jane; Senyuz, Zeynep and Weinbach, Gretchen. “The Fed’s ‘Ample Reserves’
Approach to Implementing Monetary Policy.” Board of Governors of the Federal
Reserve System, 2020; https://www.federalreserve.gov/econres/feds/
the-feds-ample-reserves-approach-to-implementing-monetary-policy.htm.
Ihrig, Jane and Wolla, Scott. “Fixing the ‘Curriculum Lag’ in Economics: The New
Tools the Fed is Using to Influence the Economy.” National Council for the Social
Studies Social Education, 2020, 84(2), pp. 93-99.
Wolla, Scott. “A New Frontier: Monetary Policy with Ample Reserves.” Federal
Reserve Bank of St. Louis Page One Economics®, May 2019;
https://research.stlouisfed.org/publications/
page1-econ/2019/05/03/a-new-frontier-monetary-policy-with-ample-reserves.
Wolla, Scott. “Fixing the ‘Textbook Lag’ with FRED (Part I): Monetary Policy in a World
of Ample Reserves.” Federal Reserve Bank of St. Louis FRED® Blog, June 10, 2019.
https://fredblog.stlouisfed.org/2019/06/fixing-the-textbook-lag-with-fred-part-i/.
Wolla, Scott. “Fixing the ‘Textbook Lag’ with FRED (Part II): Monetary Policy in a World
of Ample Reserves.” Federal Reserve Bank of St. Louis FRED® Blog, June 13, 2019;
https://fredblog.stlouisfed.org/2019/06/fixing-the-textbook-lag-with-fred-part-ii/.
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