Re: Taylor Rule: Question for Basil Moore

[Basil Moore <bmoore@xxxxxxxxxxxxxxxxx>]

John

I am afraid your simple story, even though it sounds so obvious and
logical, is not true.
The Fed strictly does not have to, and does not perceptibly change the
total amount of reserves it supplies to the banking system when it changes
the ff rate.

Even though it wishes to e.g. raise the rate, it will supply the same total
quantity of reserves to the system. Assuming the money supply and reserve
requirements remain unchanged, the quantity of total reserves demanded will
remain unchanged. The Fed supplies reserves as demanded endogenously as a
tap issue to the system. It must do this if banks are to meet their reserve
requirements and the system is to remain liquid.

What it does is change the PROPORTION it supplies as unborrowed and as
borrowed reserves. If it sells repos and reduces nonborrowed reserves, it
will force more banks into the window, and it will supply more reserves
through the discount window. But it ( granted in a nontransparent fashion)
sets the price banks must pay other banks or at the window to borrow reserves.

Tighter policy implies not a reduction in the total quantity of reserves,
but a decline in the proportion it supplies in the form of nonborrowed
reserves.

Capichio?
Basil Moore

At 03:12 PM 3/7/00 -0800, you wrote:
>Basil Moore wrote:
>>
>> Chris
>>
>> Sorry, I should have unpacked that. You remember in the textbooks the CB
>> can lower or raise rates by increasing or withdrawing reserves from the
>> sytem, which has a multiplied affect on the money supply. So the Fed can
>> lower rates if it floods the market with money, and raise them if it
>> reduces the MS.
>>
>> But in fact there is no necessity for the money supply to change
>> perceptibly for the Fed to alter the rate.
>
>The change in the quantity of reserves may not be
>perceptible but the fact remains that the quantity of
>reserves with respect to the demand for reserves must change
>for there to be a change in the value of the reserves and
>consequently the rental rate of those reserves. Because the
>demand can change without any control by the FED, the
>quantity of reserves can even decline while the FED funds
>rate decreases. The net outcome is not dependent on any
>particular level of reserves but, just like any other item
>of supply, it depends only on the quantity supplied relative
>to the demand.
>
>> It must just change the supply
>> price at which it makes reserves available to the banking system.
>
>Change in the price [i.e. -- The value of the currency.] and
>/ or the FED funds interest rate is an outcome of the FED's
>action of adding or depleting reserves AND changes in the
>market demand for reserves AND the market's perception of
>the in[de]flation rate.
>
>The market demand is not under the control of the FED.
>However, because there is no practical limit to the FED's
>ability to add or subtract reserves any change in market
>demand is completely within the ability of the FED to
>compensate for whatever change occurs. Such change may or
>may not be "perceptible" as reflected in any particular
>measure of reserves, base money or any other measure of
>money supply but that does not change the order of cause and
>effect.
>
>> It is true that if it wishes to lower rates,it will inject nonborrowed
>> reserves into the sytem. But the effect is primarily on the ff rate, not on
>> the MS. it works through changing the supply price of reserves, not the
>> quantity of reserves and money.
>
>Yes, the supply price is affected by the availability of
>reserves just as is the value of those reserves. But in
>order to change the price the action taken by the FED is to
>add to, deplete from or leave standing the quantity of
>reserves available. Although the FED also sets the discount
>rate that rate is trivial as to its effect on any other
>interest rate or the value of the currency itself because
>the FED and FDIC impose other, more meaningful, restrictions
>on borrowers from the discount window. This is why the TOTAL
>amount of reserves borrowed from the discount window is very
>seldom even as much as the monthly CHANGE in reserves.
>
>> Does this help?
>
>No, because it is obviously wrong.
>
><<SNIP>>
>
>--
>			-- jbod
>
>		Tax Privilege, Not People
>___________________________________________________
>Come visit and see a new economic perspective --
>       http://www.geocities.com/CapitolHill/1067
>           Comments/arguments welcome.
>.
>