TAILIEUCHUNG - Monetary Policy Actions and Long-Term Interest Rates

Paying interest on reserves would seem to be expensive from the Treasury’s point of view. Interest earnings ordinarily transferred by a central bank as tax revenue to the Treasury would be diverted to pay interest on reserves. Moreover, the payment of interest on reserves would induce banks to enlarge substantially the quantity of reserves demanded, greatly enlarging the interest that a central bank would have to pay. This section addresses the financing of interest on reserves, and argues that the fiscal implications are likely to be more favorable than might be supposed. Implementing an interest-on-reserves regime has two effects on. | Monetary Policy Actions and Long-Term Interest Rates By V. Vance Roley and Gordon H. Sellon Jr. It is generally believed that monetary policy actions are transmitted to the economy through their effect on market interest rates. According to this standard view a restrictive monetary policy by the Federal Reserve pushes up both short-term and long-term interest rates leading to less spending by interest-sensitive sectors of the economy such as housing consumer durable goods and business fixed investment. Conversely an easier policy results in lower interest rates that stimulate economic activity. Unfortunately this description of the monetary policy process is difficult to reconcile with the actual behavior of interest rates. Although casual observation suggests a close connection between Federal Reserve actions and short-term interest rates the relationship between policy and long-term interest rate s appears much looser and more variable. In addition empirical studies that attempt to measure the impact of policy actions on long-term rates generally find only a weak relationship. Taken V. Vance Roley is the HughesM. Blake Professor of Business Administration at the University of Washington and a visiting scholar at the Federal Reserve Bank of Kansas City. Gordon H. Sellon Jr. is an assistant vice president and economist at the bank. Th e authors would like to thank C raig Hakkio and Charles Morris for comments. Doug Rolph a research associate at the bank assisted in the preparation of the article. together the empirical studies and the observed behavior of interest rates appear to challenge the standard view ofthe monetary transmission mechanism and raise questions about the effectiveness of monetary policy. This article attempts to reconcile theory and reality by reexamining the connection between monetary policy and long-term interest rates. Using a framework that emphasizes the importance of market expectations of future monetary policy actions the article argues

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