ccounts. The end-of-day balances in these accounts are used to meet reserve and other balance requirements. If a depository institution anticipates that it will end the day with a larger balance than it needs, it can reduce that balance in several ways, depending on how long it expects the surplus to persist. For example, if it expects the surplus to be temporary, the institution can lend excess balances in financing markets, such as the market for repurchase agreements or the market for federal funds. most of the 1970s, the Federal Reserve targeted the price of Federal Reserve balances. The FOMC would choose a target federal funds rate that it thought would be consistent with its objective for M1 growth over short intervals of time. The funds-rate target would be raised or lowered if M1 growth significantly exceeded or fell short of the desired rate. At times, large rate movements were needed to bring money growth back in line with the target, but the extent of the necessary policy adjustment was not always gauged accurately. Moreover, there appears to have been some reluctance to permit substantial variation in the funds rate. As a result, the FOMC did not have great success in combating the increase in inflationary pressures that resulted from oil-price shocks and excessive money growth over the decade. late 1979, the FOMC recognized that a change in tactics was necessary. In October, the Federal Reserve began to target the quantity of reserves-the sum of balances at the Federal Reserve and cash in the vaults of depository institutions that is used to meet reserve requirements-to achieve greater control over M1 and bring down inflation. In particular, the operational objective for open market operations was a specific level of non-borrowed reserves, or total reserves less the quantity of discount window borrowing. A predetermined target path for non-borrowed reserves was based on the FOMC s objectives for M1. If M1 grew faster than the objective, required reserves, which were linked to M1 through the required reserve ratios, would expand more quickly than non-borrowed reserves. With the fixed supply of non-borrowed reserves falling short of demand, banks would bid up the federal funds rate, sometimes sharply. The rise in short-term interest rates would eventually damp M1 growth, and M1 would be brought back toward its targeted path. demand for Federal Reserve balances has three components: required reserve balances, contractual clearing balances, and excess reserve balances. reserve balances are balances that a depository institution must hold with the Federal Reserve to satisfy its reserve requirement. Reserve requirements are imposed on all depository institutions-which include commercial banks, savings banks, savings and loan associations, and credit unions-as well as US branches and agencies of foreign banks and other domestic banking entities that engage in international transactions. Since the e...
