expected levels of consumption ( campbell and cochrane, 1999 ). if policy tightens in response to inflationary shocks, term premiums also tend to rise as longermaturity bonds become riskier ( piazzesi and schneider, 2006 ). policy tightening can also lower stock prices by increasing the expected equity premium — for example, by weakening the balance sheet of leverage firms and making their stocks riskier. - 14 overall demand for goods and services in the economy, thereby reducing the demand / supply imbalances we have seen, and, consequently, reduce inflationary pressures. as a result, the inflation rate should fall back toward 2 percent, the fomc ’ s inflation rate target. a key question is how much the tightening of financial conditions since late 2021 has contributed to reducing aggregate demand and inflationary pressures. in figure 8, you can see that inflation, measured using the personal consumption expenditures price index, has started to come down. some of the disinflation, or reduction in the inflation rate, is due to monetary policy tightening, and some of this disinflation is due to other factors, such as supply chain bottlenecks easing and falling energy prices. chair powell and other colleagues in the federal reserve system have pointed out that monetary policy affects the economy and inflation with long, variable, and highly uncertain lags, and we are still learning about the full effect of our tightening thus far. 22 conclusion in conclusion, the fed has a congressional mandate of maximum employment and price stability. the fomc conducts monetary policy by setting the target range for the federal funds rate. then, the fed uses its monetary policy tools to implement the policy, which guides market interest rates toward the fed ’ s desired setting of policy. the fed implements monetary policy using administered rates. the interest rate on reserve balances is the fed ’ s primary tool for adjusting the federal funds rate. the overnight assessing the timing and magnitude of the effects of monetary policy on economic activity and inflation is both important and difficult. the challenges arise because monetary policy both responds to and influences key macroeconomic variables, because the structure of the economy may change over time, and because no two economic episodes are precisely the same. while a common theme in the economic literature is that economic activity and inflation fall in response to a tightening monetary policy shock, the estimated size and timing of the maximum effects on activity and on inflation vary substantially across studies. - 15 reverse repurchase agreement facility is a supplementary tool that sets a

##6 / feds. 2020. 022. figure 3 : fed lowers the federal funds rate by decreasing administered rates note : the blue dot indicates the previous equilibrium federal funds rate, and the red square indicates the new equilibrium federal funds rate. ffr is federal funds rate. iorb is interest rate on reserve balances. on rrp is overnight reverse repurchase agreement. source : figure 4 in jane ihrig and scott wolla ( 2022 ), “ let ’ s close the gap : updating the textbook treatment of monetary policy, ” journal of economic education, vol. 53 ( 3 ), pp. 232 – 49. figure 4 : graphical comparison of scarce - reserves regime ( left panel ) and ample - reserves regime ( right panel ) scarce - reserves regime ample - reserves regime note : ffr is federal funds rate. iorb is interest rate on reserve balances. on rrp is overnight reverse repurchase agreement. source : figure 5 in jane ihrig and scott wolla ( 2022 ), “ let ’ s close the gap : updating the textbook treatment of monetary policy, ” journal of economic education, vol. 53 ( 3 ), pp. 232 – 49. summary of fed ’ s toolbox policy implementation tools administered rates 1. interest on reserve balances ( iorb ) 2. overnight reverse repurchase agreement facility ( on rrp ) 3. discount window 4. open market operations 1. 2. iorb rate on rrp rate 3. discount rate conclusions • the fed sets the target range for the federal funds rate. • the fed uses its monetary policy tools to guide market rates toward the fed ’ s desired setting of policy. • we are currently tightening monetary policy, and changes in the federal funds rate are transmitted to other interest rates through arbitrage and by affecting investors ’ expectations. • changes in interest rates affect the decisions of consumers and businesses with a lag.