he economy. The tools available to the Fed are; open market operations, discount policy, and reserve requirements. The Fed uses all three of these tools but relies most heavily on open market operations. This is because it has a more direct impact on the economy. Buying or selling large amounts of bonds will either increase or decrease the monetary base and push interest rates up or down. Changes to the discount rate or reserve requirements are not a guarantee for an appropriate change in the monetary base because we are more dependent on the actions of the bank. The effectiveness of this strategy depends on how the banks view the excess reserves that have been created and what they do with them. Banks may be less likely to use the excess reserves for loan creation if they are worried that the Fed may readjust the reserve requirement to the old level. The chief problem when using the Fed’s policy tools to realize its goals is that the tools of the Fed do not have a direct impact on its goals. The effect is indirect and may have a substantial lag (12-18 months) before we see the desired result (or the wrong result). For this reason, the Fed uses targets to help in determining whether its policy tools are having the desired effect or not. The intermediate and operating targets that the Fed establishes are used as “sights” to keep monetary policy on track. Once the Fed executes an action using its policy tools, waiting for the effect on the desired goal would not be effective because of the lag time. Instead, the Fed can track its operating and intermediate targets to see how they are affected and if it is as expected. If so, everything is on target. If not, the Fed can make timely adjustments to how it uses its policy tools.Intermediate targets are one step removed from the monetary goals. Achieving the intermediate targets does not guarantee successfully meeting its goals but does increase the likelihood...
