risk of default on mortgage loans and the so - called prepayment risk ( that is, the risk that homeowners will choose to pay off their mortgages early ). likewise, changes in treasury yields affect stock prices by affecting both the profit prospects of publicly traded companies as well as the rate at which expected future profits are discounted to the present. basic financial theory suggests that any long - term interest rate, such as a five - year or ten - year treasury rate, is the sum of two components : a weighted average of expected short - term interest rates and a term premium, which in turn depends on risk, liquidity, and other factors affecting the desirability of the financial instrument in question. monetary policy probably influences the term premium on treasury securities to some extent. 13 however, in all likelihood, the more important means by which monetary policy affects treasury yields is through the effect of policy on the expected future path of short - term interest rates, and i will focus on that channel. expected short - term interest rates influence long - term rates because any investor has the choice of holding either a long - term security or a series of short - term securities, re - investing his or her funds in a new short - term security as the old short - term security matures. all else being equal, the choice between the two strategies depends on the expected return. if, on the one hand, short - term rates are expected to be higher on average than the long - term rate that spans the same period, investors will choose the strategy of rolling over short - term securities. if, on the other hand, the long - term rate exceeds the average of expected future short - term rates, the long - term security will be the more attractive. since both short - term and long - term treasury securities are willingly held in the marketplace, investors must be roughly indifferent between short - term and long - term securities, implying that ( on average and abstracting from any term premiums ) expected future short - term rates must be similar to the current long - term yield. you may be beginning to understand at this point why making monetary policy is not a simple matter and, in particular, why the fed has only very indirect control over long - term yields and asset prices. the fed controls very short - term interest rates quite effectively, but the long - term rates that really matter for the economy depend not on the current short - term rate but on the whole trajectory of future short -

already discussed, the demand for reserve balances arises both because banks must hold required reserves and because reserve balances are useful for facilitating transactions. because of the scale of and volatility in daily payments flows, the demand for reserve balances can vary substantially from one day to the next. the supply of reserve balances is largely determined by the federal reserve - at the operational level, by the specialists at the federal reserve's open market desk, located in the federal reserve bank of new york in the new york financial district. for example, to increase the supply of reserves, the open market desk purchases securities ( usually government securities ) on the open market, crediting the seller with an increase in reserve balances on deposit at the fed in the amount of the purchase. 9 thus, a purchase of a billion dollars'worth of securities by the open market desk increases the supply of funds available to lend in the fed funds market by the same amount. similarly, sales of securities from the fed's financial portfolio result in debits against the accounts of commercial banks with the fed and thus serve to drain reserve balances from the system. 10 collectively, these transactions are called open - market operations. factors outside the control of the open market desk can also affect the supply of reserve balances. for example, when the federal reserve receives an order for currency from a bank, it debits the reserve account of the bank in payment when the currency is shipped, thereby reducing reserve supply. when deciding upon open market operations to control the supply of reserves, the open market desk must take account of these external factors. in practice, the open market desk uses several methods of performing open - market operations. in some cases it purchases securities outright, that is, with the intention of holding the securities in its portfolio indefinitely. outright purchases are used to offset long - lasting changes in factors affecting the demand for and supply of reserves. for example, long - term increases in the private sector's demand for currency have largely been met by outright purchases of securities. over the years, the fed has accumulated a portfolio of more than $ 700 billion of treasury securities, mostly as an offset to its issuance of currency. in contrast, in cases in which variations in the demand for reserves or in external factors affecting reserve supply appear likely to be temporary, the desk typically prefers to conduct open - market operations through short - term or long - term repurchase agreements, known as repos. under a repur