"Confidence in the Implementation of U.S. Monetary Policy Normalization"
Remarks by
Simon M. Potter
Executive Vice President
Federal Reserve Bank of New York
at the
23rd EMEAP (Executives' Meeting of East Asia-Pacific Central Banks) Governors' Meeting
Manila, Philippines
August 4, 2018
Thank you for the invitation to participate in today's discussion about globalization and
its effect on monetary policy in emerging market economies.1
U.S. financial markets, and the U.S. monetary policy stance, can significantly influence
global financial conditions and capital flows.2 In no small part, this reflects the extensive use of
the dollar in international trade and in financial transactions conducted outside the United States.
The pricing and availability of financing for business activity around the world-even activity
that does not directly relate to an American borrower, lender, producer, or consumer-often are
influenced by conditions in U.S.-dollar money markets. And, understandably, the evolution and
stability of dollar funding markets are a focus of attention for many economic policymakers
around the world, especially here in the East Asia-Pacific region. As always, the views I will
express today are mine alone and do not necessarily reflect those of the New York Fed or the
Federal Reserve System.
My remarks today will focus on the implementation of monetary policy normalization in
the United States and its contribution toward maintaining stability in U.S.-dollar money markets.
I will start by reviewing progress on the Federal Open Market Committee (FOMC)'s program to
normalize the stance of monetary policy. The FOMC has carefully laid out a clear and
transparent normalization strategy and is implementing that strategy, and I believe that the
confidence engendered by this clarity and transparency has been of great importance in
maintaining market stability, both in the United States and globally. Experience so far has
shown that the Federal Reserve's monetary policy implementation framework has continued to
provide appropriate control over the federal funds rate, even as the FOMC has moved to reduce
the size of the balance sheet gradually and predictably. This stability has supported the orderly
functioning of the broader set of dollar money market rates that are important to financial
conditions in the United States and around the world.
Then, I will discuss the recent technical adjustment to the rate of interest paid on reserves
(IOR). The Federal Reserve made the adjustment to provide greater comfort that the effective
federal funds rate would remain within the target range set by the FOMC.3 I will discuss how
this adjustment has had exactly the intended effect on money market conditions, and how it has
reinforced my certainty that the Federal Reserve is well positioned to maintain the public's high
1
I would like to thank James Egelhof, Jacqueline Yen and Samuel Zief for their assistance in the preparation of
these remarks, Vivek Manjunath for his assistance with data, and colleagues in the Federal Reserve System for
numerous insightful comments and suggestions.
2
See Powell, "Monetary Policy Influences on Global Financial Conditions and International Capital Flows," May 8,
2018.
3
The effective federal funds rate is calculated as a volume-weighted median of overnight federal funds transactions
reported by banks on the FR 2420 Report of Selected Money Market Rates. The New York Fed publishes the EFFR
for the prior business day, along with volumes and rate percentiles, on its website daily at approximately 9:00 a.m.
Eastern Time. The EFFR is used as a measure of the typical fed funds transaction and is the way the New York
Fed's Open Market Trading Desk (the Desk) measures its success in meeting the directive on interest rate control
from the FOMC.
confidence in its ability to appropriately control overnight interest rates over the period of
normalization.
I will then conclude with some comments on recent developments in broader money
market rates, in particular U.S.-dollar LIBOR. U.S. term money market rates are of global
significance, owing to the heavy use of the dollar outside the United States and the large stock of
dollar-LIBOR-linked debt issued abroad.4 The spread of LIBOR to overnight indexed swaps has
fluctuated in recent years, along with similar term unsecured dollar borrowing rates, driven in
part by the same factors influencing overnight rates but also by specific past regulatory and
legislative changes that have impacted flows in term markets. Evidence, such as from the FX
swaps market, suggests that dollar borrowing markets continue to function well.
Policy Normalization Continues As Expected
I'd like to start by taking stock of where we are with the normalization of monetary
policy in the United States. The Federal Reserve entered this tightening cycle with its overnight
policy rate at the zero lower bound and with a large portfolio of long-duration securities.
Normalization, therefore, has two parts: increasing the overnight rate, and reducing securities
holdings to a smaller size. The FOMC began raising the overnight rate from zero in late 2015,
and it began reducing the size of the portfolio late last year.
First: overnight rates. Due to the large supply of reserves that has accompanied the
Federal Reserve's expanded balance sheet, we are employing a new and innovative framework to
control money market rates.5 Before the financial crisis, the Federal Reserve followed a
wellworn playbook for monetary policy implementation that was based on keeping reserve balances
scarce. Nowadays, however, reserves are no longer scarce. Our current framework relies,
instead, on providing the market with two overnight investment opportunities to help steer
money market rates: interest on reserves (IOR), which is the Federal Reserve's main tool to
control interest rates, and the overnight reverse repurchase agreement (ON RRP) facility, a
secondary tool.
The current framework is simple and efficient to operate. In contrast, in the pre-crisis
regime, hitting the target federal funds rate each day was a technically challenging exercise.6 We
also have now had more than two and a half years to observe the performance of this framework,
4
These remarks focus on dollar money markets, many of which are linked to LIBOR, and do not discuss the
reference rate itself. Dudley, "The Transition to a Robust Reference Rate Regime," May 24, 2018, offers
perspective on the outlook for LIBOR as a reference rate.
5
Potter, "Money Markets after Liftoff: Assessment to Date and the Road Ahead," February 22, 2016, provides a
detailed discussion of the new framework. For a discussion of the new and old frameworks see Ihrig, Meade,
Weinbach (2015)
6
See Logan, "Operational Perspectives on Monetary Policy Implementation: Panel Remarks on The Future of the
Central Bank Balance Sheet," May 4, 2018, for a comparison of the technical operation of the pre-crisis and current
frameworks.
and it has proven to be extremely effective at controlling federal funds rates. As shown in Figure
1, it has maintained the effective federal funds rate within the FOMC's target range on all but
one day over the entire period.7 Looking at the distribution of traded rates within both the
federal funds and overnight bank funding markets, as shown in Figure 2, it is also clear that the
framework has broadly fostered trading at rates within the target range. Indeed, the difference
between the 25th and 75th percentiles of the rate distribution has consistently remained very tight
over the course of normalization.8
Of course, monetary control does not stop at the federal funds market: our framework
must ensure that the stance of monetary policy is passed through into other money markets. It
has also been very successful in this sense. Figure 3 shows a broad selection of secured and
unsecured overnight money market rates; it is clear that increases in the target range for the
federal funds rate have passed through fully and immediately to the other rates, as expected and
intended. Moreover, I have been very encouraged by the relative stability and high degree of
comovement among short-maturity money market rates.
And second: the balance sheet.9 The Federal Reserve's balance sheet grew markedly
earlier this decade as a result of large-scale asset purchase programs, which were undertaken to
support the economic recovery by easing financial conditions to a greater extent than could be
achieved solely through reducing the federal funds rate. For many years, the FOMC has
indicated its intention that the Federal Reserve will, in the longer run, hold no more securities
than necessary to implement monetary policy efficiently and effectively, and that it will hold
primarily Treasury securities.10 Starting late last year, the Federal Reserve began a program to
reduce its securities holdings by reinvesting principal maturities only to the extent that they
exceed gradually increasing caps.11 This gradual and predictable approach is intended to reduce
the balance sheet's size at an appropriate pace while supporting good market functioning and
mitigating the risk of sharp or outsized asset price reactions.
The charts in Figure 4 show the evolution of the Federal Reserve's securities portfolio.
Up to the present, the full length of the bars show the actual amounts of Treasury securities and
agency debt and MBS principal that matured or paid down early. Only the amounts above the
cap were reinvested. As can be seen, we have delivered a gradual and predictable reduction in
7
This one day was December 31, 2015, when the federal funds rate printed at 20 basis points, or five basis points
below the bottom of the FOMC's target range. Potter, "Money Markets after Liftoff: Assessment to Date and the
Road Ahead," February 22, 2016, discusses this occasion.
8
I discussed dispersion as a means to evaluate the efficacy of monetary control and transmission in an earlier
speech. These data suggest that the framework continues to perform quite well along this dimension. See Potter,
"Money Markets at a Crossroads: Policy Implementation at a Time of Structural Change," April 5, 2017.
9
See Potter, "Gradual and Predictable: Reducing the Size of the Federal Reserve's Balance Sheet," October 11,
2017, for a discussion of balance sheet normalization.
10
See the FOMC's Policy Normalization Principles and Plans, September 16, 2014.
11
Statement Regarding Reinvestment in Treasury Securities and Agency Mortgage-Backed Securities, September
20, 2017.
the size of the balance sheet. This has been accomplished without any evidence of market
disruption or volatile price movements; it has been, as former Chair Janet Yellen once said, like
"watching paint dry."12
The charts in Figure 4 also show the projected progression of the portfolio for the rest of
the year. Runoff from the balance sheet increases over the projection horizon, as the caps attain
their terminal value later this year. As had been expected at the start of the program, principal
repayments from our agency MBS portfolio are projected to eventually start coming in below the
level of the caps. Based on current projections, principal payments on the Federal Reserve's
holdings of agency MBS would likely be lower than the monthly cap on redemptions that will be
in effect beginning in the fall of this year. Consistent with the Policy Normalization Principles
and Plans, when this occurs in a given month, no reinvestment occurs, and the portfolio size
declines by the amount of principal repayment. It is important to remember that mortgage
principal repayments are uncertain; are sensitive to various factors, particularly long-term
interest rates; and could conceivably rise above the level of the cap in the future, particularly if
interest rates were to decline. If this were to occur, those amounts above the cap would be
reinvested. The cap-based program to normalize the balance sheet was designed at the start to
operate exactly in this way: it is the mechanism by which the decline in the balance sheet is kept
to a gradual and predictable pace. I expect that the Desk will conduct operational readiness
exercises during periods of no reinvestment to ensure it remains prepared to reinvest if needed.13
Flexibility When Needed: The Technical Adjustment
All of this news is encouraging, and it confirms the efficacy of the FOMC's plan to
normalize the stance of policy. I'd like to turn back to overnight rates for a moment, to speak
about the recent technical adjustment to the IOR rate and try to answer a few questions that have
emerged.
Although they remained within the FOMC's target range, rates paid on the bulk of
federal funds trading had ticked up, as can be seen in Figure 5. By April 2018, the effective
federal funds rate was five basis points below the top of the range. This rise raised a question as
to whether the effective federal funds rate might print above the top of the FOMC's target range,
absent a change in our operational settings.
The target range is an important feature of the FOMC's public communications, and
maintaining federal funds rates within it is therefore taken quite seriously. Public confidence in
our ability to maintain rates within the target range is important for ensuring that expectations for
the FOMC's future policy stance are properly incorporated into the term structure of interest
rates, and thereby appropriately affect financial conditions and the broader economy.
To address the rise, the Federal Reserve made a technical adjustment to the IOR rate at
the June FOMC meeting, raising it by 20 basis points while increasing the target range by 25
basis points.14 The technical adjustment worked exactly as we expected. As you can see back in
Figure 2, all rates paid on federal funds borrowings, as well as in other money markets, rose by
about 20 basis points. This made it less likely that the effective federal funds rate would be
above the top of the target range.
Let's spend a few minutes exploring what drivers might have been most significant in
bringing about the rise in money market rates relative to IOR.15 Leading into the technical
adjustment, a shift in flows in the Treasury market had the effect of pushing both Treasury bill
yields and repo rates higher in February and March. Figure 6 shows cumulative net Treasury bill
issuance since the beginning of last year, as well as projections through the third quarter of this
year as reported by a private-sector forecaster. The substantial run-up in net bill issuance over
the past few quarters, along with other factors, contributed to notable growth in securities
dealers' inventory of Treasury securities, shown in Figure 7-inventories that likely required
financing in the repo market. Before these developments, Treasury bill yields and repo rates had
been well below federal funds rates. The increases created an attractive alternative investment
opportunity for federal funds lenders, including the Federal Home Loan Banks (FHLBs), which
make up about 95 percent of current overnight lending in the federal funds market. Figure 8
shows that as repo rates rose relative to federal funds rates, volumes of FHLB lending in the repo
market increased as some of the FHLB activity shifted into this market. As federal funds
borrowers competed for this reduced pool of funds, rates rose.
You may notice on Figure 1 that the federal funds rate had been rising within the range
well before these recent shifts in Treasury market flows. This gradual and slow rise coincided
with the ongoing decline in reserve balances that is a part of balance sheet normalization, which
has raised the question of whether the decline in reserves might be putting upward pressure on
overnight rates.
In the academic literature on monetary policy implementation, models for the behavior of
the overnight interbank rate generally boil down to its relationship with the stock of bank
reserves.16 These models generally find that as reserve balances decline, the overnight interest
rate goes up, but not uniformly. At high levels of reserves, the responsiveness of rates to
changes in reserve levels is fairly low, and the demand curve is said to be "flat." As excess
reserve levels decline, the responsiveness of rates increases. At low levels of excess reserves, the
overnight rate responds sharply to small adjustments in the level of reserves: the demand curve is
"steep."
It seems highly likely that we are on the "flat" part of the curve, the part where rates
move little in response to shifts in reserves. But this does not quite answer the question on
whether the decline in reserves might be putting perhaps some upward pressure on rates. Even
in the "flat" part, the slope of the demand curve, while small, might be nonzero. This could be
true if, for example, the balance sheet costs of the marginal borrower in overnight money
markets were upward sloping with respect to that bank's balance sheet size. I see this as a
reasonable possibility, and therefore I think it might be possible that the decline in reserve
balances has pushed up overnight rates a bit over time.17
At this point, I see no evidence that we are at, or close to, the "steep" portion of the
demand curve.18 Let's run through some places where evidence of such a possibility might be
found. To begin with, if we were closing in on the "steep" part, I might have expected to see
more above-IOR lending in the unsecured overnight markets, as at least some banks each day
found themselves short of reserves and had to borrow them from another bank. In fact, the
amount of such above-IOR lending remains low as a share of the overnight bank funding market,
as shown in Figure 9.19 I might also have expected to see shifts in bank payments behavior-for
example, more daylight overdrafts or more effort by banks to "optimize" their payment flows-
but I have not seen this either. But, most fundamentally, I might have observed a day-to-day
relationship between shifts in the stock of reserves and overnight interest rates. Figure 10 shows
a scatterplot of daily changes in reserve balances against daily changes in the spread between the
IOR rate and the effective federal funds rate; there is no visible relationship.
16
The classic paper on this topic is Poole (1968). A number of recent efforts have been undertaken to modernize the
Poole model by adding interest on reserves and other features of modern money markets. Two notable examples of
this are Schulhofer-Wohl and Clouse (2018) and Afonso, Armenter, and Lester (2018).
17
Alternatively, it could be that banks are more efficient in their balance sheet management, which would be
consistent with the lower volatility in overnight rates we have seen at recent quarter-ends. Bargaining dynamics
within overnight money markets, which exhibit a fairly high degree of concentration of both borrowing and lending,
could also have played a role in the rise over time in market rates relative to IOR.
18
For a further discussion of the shape of the demand curve for reserves and its implications for policy
implementation, see Logan, "Operational Perspectives on Monetary Policy Implementation: Panel Remarks on The
Future of the Central Bank Balance Sheet," May 4, 2018.
19
In the spring there was an increase in borrowing in the federal funds market above IOR, but volume in the
Eurodollar market decreased around the same time.
Let me offer some caveats to these observations. Money markets have been and are now
changing quickly in response to regulatory, technology and business model incentives.20 At the
same time, reserves in the system have been abundant because of the asset purchase programs-
perhaps smoothing through the effects of some of these changes. Staff at the Federal Reserve
has been using new data sets, analytics, and extensive market intelligence to deepen our
understanding of the impact of these changes on money market dynamics. What follows is an
illustration of this enhanced understanding.
In the pre-crisis monetary policy framework, banks' regulatory obligation to hold
reserves was primarily driven by the required reserves framework, set forth in the Federal
Reserve Act and Regulation D.21 This framework involved banks meeting their requirement
over a 14-day reserves maintenance period, as well as various other incentives that promoted
short-term, but not extremely high-frequency, bank balance sheet management activity to
maintain reserves at required levels-and the Federal Reserve had built analytics to provide good
visibility into it. Today, while the Regulation D framework is still around, it is no longer likely
to be the binding constraint on reserve levels for most large banks.22 The new factors driving
reserves demand appear to vary by financial institution, and seem to depend on a complex
interplay of numerous new features of the financial system. On the regulatory side, these include
the Liquidity Coverage Ratio (LCR), banks' internal stress tests of their liquidity adequacy,
supervisory expectations related to banks' ability to monetize their liquidity portfolios during
periods of financial stress, and the incorporation of liquidity into resolution planning. Other
important factors include increased bank aversion to incurring intraday overdrafts, higher bank
investor and creditor expectations for liquidity, and a lower opportunity cost of holding reserves
relative to before the crisis.23
Not only will this system likely mean that banks' binding constraint on reserve levels will
be different from before the crisis, but also that bank behavior when reserves decline will likely
be different. For example, in comparison to the 14-day maintenance period I mentioned earlier
under Regulation D, many of these new constraints are measured quarterly, while some are
measured daily for certain purposes. This means that signs of reserve scarcity may emerge
differently and on a different timescale than they would have in the old system. Moreover, banks
20
For example, there has been an expansion of access to centrally-cleared repo, through the introduction of the GCF
Repo Service's Centrally Cleared Institutional Triparty Service (CCIT), which opened the centrally-cleared triparty
repo market to institutional cash lenders, and the growth of activity in the centrally-cleared bilateral repo market by
institutions being sponsored by members of the Fixed Income Clearing Corporation's (FICC) Government Securities
Division. Separately, some foreign banking organizations that had been active borrowers in the offshore Eurodollar
market have shifted their borrowing in favor of domestic deposits that are economically similar to Eurodollars.
21
Kroeger, McGowan, and Sarkar (2018) provides detailed background on behavior of the pre-crisis framework.
22
The Regulation D reserve requirement is still binding for many smaller banks.
23
It is important to note that these new regulatory and behavioral factors are related to liquidity in general and not
strictly about reserves held in Federal Reserve accounts as in Regulation D. Banks have many possible means for
addressing their requirements under the LCR, and the LCR rule does not impose any specific requirement to hold
central bank reserves.
have various ways to meet their obligations under this system: their choices are not limited to
simply holding more reserves. As a result, reserve scarcity may be accompanied by shifts in
market pricing and flows that we might not have seen in the old framework. Finally, the old
system provided a degree of stability over time through its ability to reallocate scarce reserves
among banks in response to shocks through interbank lending in the federal funds market. This
interbank activity largely dried up following the crisis and has not meaningfully returned-in
part due to regulatory incentives, but also because banks report that they are now less interested
in taking on financial exposure to other banks.24 As a result, it is possible that a regime of less
abundant reserves may now be accompanied by an element of increasing volatility or periodic
turbulence in money markets.
One new way in which scarcity might manifest itself going forward is through effects
related to the LCR. Very generally, the LCR is designed to ensure that banks hold a sufficient
reserve of high-quality liquid assets (HQLA) to allow them to survive a short-term period of
significant liquidity stress. Now, balance sheet normalization involves reducing the private
sector's holdings of one type of LCR HQLA, reserves, and increasing others-Treasuries and
agency MBS-by an equal aggregate amount, so normalization does not make HQLA writ large
more scarce.25 However, within the universe of HQLA, reserves are especially liquid: they can
be used to make payments at any time without the need to sell or finance an asset in financial
markets, which in a stressed environment might be difficult or costly. As a result, as the
aggregate stock of reserves declines over balance sheet normalization, competition among banks
may intensify for ways to bolster their measured liquidity position.26
Such increasing competition could affect money markets by increasing the differential
between different types of money markets borrowing based on its treatment under the LCR. The
LCR determines a bank's expected cash outflows by multiplying the outstanding balances of
various categories of liabilities by various supervisory "runoff rates," which are meant to reflect
the relative "stickiness" of that type of liability.27 Borrowing cash in overnight wholesale
markets from another financial institution, such as a bank or a money market mutual fund, does
not help a bank's liquidity position as measured by the LCR, because the rule assumes this
funding completely runs off during periods of financial stress.28 However, borrowings from
certain other kinds of lenders, such as public-sector entities, foreign central banks, and
24
Potter, "Discussion of 'Evaluating Monetary Policy Operational Frameworks' By Ulrich Bindseil,"August 26,
2016. Discussions with banks suggest both the incentives and operational preparedness for large scale interbank
unsecured transactions is low.
25
The decrease in reserves is generally matched by an equal increase (as measured by market value) in securities
under most assumptions. See Leonard, Martin, and Potter, "How the Fed Changes the Size of its Balance Sheet,"
July 10, 2017, for a discussion of some technical factors that could result in the values not being exactly the same.
From an LCR perspective, reducing agency MBS holdings can affect banks' measured LCRs to a moderate extent
because agency MBS are Level 2 HQLA and are counted with an 85 percent weighting.
26
Quarles, "Liquidity Regulation and the Size of the Fed's Balance Sheet," May 4, 2018.
27
See Liquidity Coverage Ratio (LCR) - Executive Summary and Bech and Keister (2017)
28
Basel III: The Liquidity Coverage Ratio and liquidity risk monitoring tools, page 73.
nonfinancial corporations, receive lower runoff rates, as the LCR rule considers these types of
lenders to be "stickier." In particular, borrowing from the FHLBs, the predominant lenders in
the federal funds market, is one example of LCR-favored wholesale borrowing. So, if banks
were becoming more interested in improving their LCRs, they might seek out, and pay up for,
loans from the FHLBs and other LCR-favored lenders.
Recent data indicates that LCR-related demand has pushed up the effective federal funds
rate at times, notably in June. Looking at the distribution of federal funds rates this year, Figure
11 shows that the rates paid by domestic banks has increased relative to the rates paid by foreign
banks. Last year, these two types of firms paid fairly similar rates. My read is that the foreign
banks are generally borrowing in the federal funds market primarily to earn a spread between the
IOR rate and the rate they pay to borrow funds, while some of the domestic banks, while also
sensitive to the rate they pay, are borrowing in these markets to improve their LCRs. It seems
like this more motivated borrowing activity helped bid up rates a bit. Figure 12 shows that, since
June, we have seen small and brief divergences between rates in the federal funds and Eurodollar
markets, which reflects transitory pricing of a premium on LCR-friendly borrowings around a
period of heavy payment flows due to a federal tax payment due date.29 This small effect is a
minor illustration of the transitory money market "turbulence" I mentioned earlier. However,
since these effects have been small and short-lived, I don't see them as signaling that we are at or
close to reserve scarcity.
Taking a step back, it is hard to be definitive on the recent drivers of moves in short-term
money markets. The markets have economically complex structures, and in particular, a high
degree of concentration within some money market segments. Further, the prevalence of
standing business relationships has seemed to mean that in practice transitory shocks can have
more permanent effects on pricing. Indeed, despite a recent decline in repo rates, the effective
federal funds rate has remained fairly stable at nine basis points below the top of the range.30
Moreover, there have been various other recent shocks that may have influenced money market
flows and structure, such as those from recently enacted tax reform measures.
There are various opinions in the market on how things go from here. Some believe that
we might see federal funds rates remain at a similar spread to IOR or rise somewhat closer to
it-for example, due to a forecasted seasonal increase in net Treasury bill issuance heading into
29
In particular on June 20 and 21 our market intelligence and analysis of data suggest that LCR-motivated
borrowing from FHLBs by a few banks placed modest upward pressure on traded rates in the federal funds market.
A contributing factor was a decline in funds supplied into the market from the FHLBs, due to an increase in demand
for advances around the mid-month tax date. Data on historical traded rates in the Eurodollar market are published
with a quarterly lag as part of the New York Fed's Quarterly FR 2420 Summary Statistics release.
30
Indeed, an alternative explanation for the movement of federal funds trading further up in the range since lift-off
could be FHLBs gaining more bargaining power with banks as they observe counterparties being willing to trade at
higher rates. A good example of this was in December 2014 when temporary testing of different offering rates on
the ON RRP produced a persistent increase in the level of federal funds trading.
the end of the year. Others see the recent tightening of federal funds to IOR as overly large
relative to historical experience, and think this will retrace somewhat.
Based on what I know now, it seems like a strong possibility that rates paid on borrowing
in the federal funds market will remain within the target range for now with the current settings
of the Federal Reserve's monetary policy toolkit. But, more importantly, I am confident that the
Federal Reserve has the capacity to ensure that it will continue to achieve its goals, such as
through another technical adjustment, should such action seem appropriate. What matters to the
public and for broad financial conditions is the effective stance of monetary policy, which at the
Federal Reserve is communicated by the target federal funds range and its transmission to other
money markets.
Fluctuations in Term Money Markets
Let's shift gears and talk about term dollar money markets. As I just discussed, the
Federal Reserve's policy target is the federal funds rate, which is an overnight rate of interest in
the wholesale market. While the goals for monetary policy are maximum employment and price
stability, the economic decisions of households and firms generally don't depend directly on the
federal funds rate, since these parties do not participate in that market. Instead, their decisions
depend on broader financial conditions, including the interest rates on home mortgages and
corporate bonds, the performance of the stock market, and the foreign-exchange value of the
dollar. As a result, for monetary policy to achieve its objectives, markets must function well
enough to transmit the stance of policy, both from the markets in which the Federal Reserve
directly transacts to its policy target, and then onward from that target to other money markets,
and eventually to asset prices (bond yields, mortgage rates, equities, and exchange rates) that
more directly affect real activity in the U.S. economy.
Because the various money markets are important to achieving the Federal Reserve