Discussion of Recent Developments in Federal Reserve System Liquidity and Reserve Operations

In the monetary policy function, the Fed uses its powers as the ultimate supplier of liquidity to achieve the proximate target of monetary policy. Essentially, the Fed supplies a level of reserves to achieve the overnight Fed funds target rate, the fi rst step in the transmission of monetary policy. The paper outlines this process and highlights the current challenges of achieving the target, particularly during periods of market turbulence. Required reserves are no longer suffi cient to buffer large unanticipated payment fl ows, which means that there is greater potential for volatility in the overnight Fed funds rate. This is accentuated by the lack of appropriate price incentives to help ensure that Fed funds trade around target given that the rate is bounded by a fl oor of zero (with the Fed unable to pay interest until 2011) and by a ceiling rate on the discount rate (where access to the primary credit facility is affected by ‘stigma’).