Market for Reserves and Conventional Monetary Policy

What is the cost of excess reserves?

Interest that could’ve been earned from lending - interest paid on excess reserves.

What increases the demand for reserves?

The fed’s fund rate

What is the cost of borrowing from the Fed?

Discount Rate

What happens when the Federal Funds Rate (Iff) is greater than the interest paid on reserves (Ior)

Banks won’t borrow from the Fed, and borrowed reserves are zero.

What are the four main tools used by the FED?

Open Market Operations, Changing the Required Reserve Ratio, Changing Interest Paid on Reserves (Ior), Changing the Discount Rate (Id)

Why does the Fed use open market operations?

To influence the federal funds rate, which is the target interest rate for overnight lending between banks. By buying government securities, the Fed injects money into the banking system, which lowers the federal funds rate and vise virsa. 

What are the two parts of open market operations?

Dynamic and Defensive

What are the pros and cons of  the reserve requirment?

All banks hold the same minimum amount of funds but it can cause liquidity problems and make banks more uncertain

When is it appropriate to use interest on excess reserve as a tool?

When banks hold high amounts of excess reserves

What are the pros of open market operations?

Flexible, precise, quick, and easily reversed

What are the pros and cons of using the discount rate as a tool?

Allows the Fed to act as a lender of last resort but create the zero-bound problem.