Domestic Open Market Operations during 1999 - Statistical Data Included

Federal Reserve Bulletin, July, 2000

This report was adapted from one presented to the Federal Open Market Committee by Peter R. Fisher, Executive Vice President of the Federal Reserve Bank of New York and Manager of the System Open Market Account. Spence Hilton was primarily responsible for the preparation of this report, with the assistance of many other members of the Markets Group at the Federal Reserve Bank of New York.

IMPLEMENTATION OF MONETARY POLICY IN 1999

Directives of the Federal Open Market Committee

In 1999, the directives issued by the Federal Open Market Committee (FOMC) instructed the Trading Desk at the Federal Reserve Bank of New York to foster conditions in reserve markets consistent with maintaining the federal funds rate at an average around a specified rate, which is commonly referred to as the federal funds rate target. The FOMC raised the federal funds target three times during the year at a scheduled meeting, each time by 25 basis points (table 1). On the last two of these dates, the Board of Governors approved increases of equal size in the discount rate. The public announcement released after the conclusion of the May FOMC meeting was the first to indicate the bias that the Committee had adopted in its directive. But the bias that the Committee adopts at any time has no direct implications for the daily selection of open market operations.

1. Changes in the federal funds rate specified in directives
of the Federal Open Market Committee

Percent
                      Expected       Associated
Date of change      federal funds   discount rate
                        rate

November 17, 1998       4.75           4.50
June 30, 1999           5.00           4.50
August 24, 1999         5.25           4.75
November 16, 1999       5.50           5.00

Overview of Operating Procedures and Practices

The Desk used open market operations to align the supply of deposit balances held by depository institutions at the Federal Reserve with the level of demand believed consistent with maintaining the funds rate around its target level. Each morning the Desk considered whether open market operations were needed based on estimates of the supply of, and demand for, balances, and any operation designed to alter balances that same day was typically arranged shortly afterward. Estimated needs for balance adjustments in upcoming days and weeks, an assessment of possible forecast errors, and current and anticipated trading conditions in the federal funds markets were all considered when selecting the type and size of operations.

The ability of depository institutions to average their holdings of balances at the Federal Reserve over two-week maintenance periods to meet their reserve and clearing balance requirements gives them some flexibility in managing their accounts from day to day. This ability to average is an important source of elasticity in banks' daily demands for balances, limiting the volatility in rates that can develop when the Desk misestimates either the supply of or demand for balances. Nonetheless, the funds rate will firm if the level of balances falls so low that some banks have difficulty finding sufficient funds to cover late-day deficits in their Federal Reserve accounts. On the other hand, the rate will soften if balances are so high that some banks risk ending a period holding unusable excess reserve balances. The Desk weighs these possibilities every day when deciding what level of balances to leave in place. As depositories have found ways to avoid incurring reserve requirements, the degree of elasticity across days has diminished, and the Desk has had to pay increasing attention to daily fluctuations in the supply of and demand for balances.

The effectiveness of the Desk's operating procedures for maintaining control over the federal funds rate rests on the existence of liquid short-term financing markets. Trading in the overnight federal funds market is a critical mechanism through which the supply of balances at the Federal Reserve is distributed among banks, while the Desk intervenes in the short-term market for repurchase agreements to make most of its adjustments to the supply of these balances. These two markets must be functioning efficiently for the current operating procedures to work effectively.

In advance of the year-end, there was concern about whether levels of trading and intermediation in the financing markets around the century date change would be sufficient for the Desk's usual operating procedures to work effectively because some market participants had expressed a reluctance to maintain normal levels of activity in financing markets at that time. The Desk also believed that the large projected reserve deficiencies around the year-end could potentially strain its ability to meet reserve demands with its existing practices. How the Desk prepared for and carried out open market operations in the months leading up to and in the days immediately surrounding the rollover date is a major focus of this report.

New Developments in 1999