Saturday, 19 October 2019: 5:10 PM
The process by which most central banks’ target nominal interest rates and implement monetary policy has changed considerably in the last 20 years. In 2006, the Financial Services Regulatory Relief Act authorized the Federal Reserve Banks to pay interest on balances held by or on behalf of depository institutions at Reserve Banks, which enabled the Fed to use it as a new tool. The use of interest payments on reserves and the decoupling of rate targets (e.g. the fed funds rate) from reserve targets now play a key role in the policy decisions of central banks. Yet, in introductory macroeconomics textbooks, the discussion of reserves is focused on the relation of required and excess reserves to the deposit multiplier and money stock. They further discuss interest rate targeting as being achieved through effective adjustments to the money supply. The main problem with that focus is that the target fed funds rate is not realized through dependence on the money multiplier or strict control of the money stock. It is achieved today through a process of paying interest on reserves and creating a floor that sets the target rate. Today’s policy implementation leaves the amount of reserves in the system largely independent of the targeting process. Textbooks and the associated classroom discussions leaves students completely unaware of the actual process used to target rates and with an unrealistic interpretation of the money multiplier’s importance. This causes problems for people making decisions for personal finance and portfolio management reasons. We survey commonly used introductory macroeconomic books to highlight what is currently taught and how it can be changed to reflect the current practice used in central banks today. We will also provide the key learning objectives needed in introductory macroeconomics course pedagogy to transform outdated monetary policy implementation discussions to one consistent with current Federal Reserve Bank practices.