Wednesday, August 5, 2009

the mechanics of open-market operations

the Federal Open Market Committee (FOMC) meets eight times each year in Washington, D.C. Its staff briefs the committee on current economic conditions and future projections in what is referred to as the "chart show." the FOMC then issues a directive, which is an instruction to the two managers of the open-,market accounts. One manager heads domestic operations;the other heads foreign operation. Both managers are vice presidents of the New York Fed. The New York Fed serves as the agent of the twelve Federal reserve banks in conducting open-market operations, and the two managers take their orders from the FOMC.
the FOMC directive to the account managers consists of three parts:
1- PART a contains the qualitative statements of the stabilization goals, for example, higher employment,lower inflation, stable growth of real output, and a balance-of-payments improvement.
2- part b include the specific target ranges for the next year (from the current quarter to the corresponding quarter one year later). The targets have varied over the years, but usually they are stated in terms of credit conditions, interest rates, or monetary aggregates
3- part c lists short-term targets that take into account special calender events (such as Christmas, when currency leakages are unusually large) but are consistent with the goals in part B.
It is important to realize that the FOMC directive does not set specific targets for reserves in the system. It is up to the account managers to decide the dollar value of the securities to be bought or sold on the open market to achieve the results mandated in the directive. of course, the discretionary power of the managers is not unlimited. if the FOMC Changes its mind or feels that its directives are not being carried out properly, it can issue additional verbal instructions to the account mangers before the next meeting of the FOMC.
Although the directive eventually is made public (currently at the end of 30 days), it is not made public immediately. the reason the Fed gives for keeping the directive secret for three or four weeks is that it believe some people are in a position to act upon this information more rapidly than others and thus can earn profits at the expense of others. Carrying this policy of secrecy to the extreme, the domestic account manager at the new york Fed actually places buy sell orders simultaneously with different dealers, so that it is not immediately apparent whether the Fed is a net buyer or a net seller. this attitude of secrecy is not without its critics; some feel that in this day of modern electronic communications, the Fed should announce its directive immediately and publicly. It is difficult to understand how immediate disclosure could help some and hurt others in any systematic fashion. But it is easy to see how policy of secrecy places high premiums on inside information.
Day-to-Day Operations Once the account managers have received their directive, they brief the members of their trading staffs and the action begins. In particular, the domestic account manager contacts the three dozen or so special dealers in government securities who are located in New York City; the securities dealers in turn deal with the public. because the Fed is a semipublic institution (it is owned by member banks, but its top officials are governmental appointees), its activities are under scrutiny; therefore, it strives to sell at the highest price and buy at the lowest price in its open-market operations.
It is often true that no physical paper check is necessary for an open-market transaction. Fedwire links the district Reserve banks to commercial banks, which act as clearing agents for the special dealers in government securities. Computers linked through Fedwire debit and credit transactions to the security book-entry accounts of the depository institutions in question, typically on the same day as the transaction. The open-market operations of any day last only about a half hour.
the Fed buys and sells many times the volumes of the net changes in the monetary base that its open-market operations produce. Individual open-market purchases or sales typically involve millions of dollars in securities.

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