"
Nonborrowed Reserve Targeting and Monetary Control," in Laurence H.
A change in Federal Reserve policy in October 1979 away from supplying liquidity and toward a
nonborrowed reserve target caused greater volatility in the federal funds rate, and therefore more uncertainty of the costs associated with bank reserve management (Barret, Slovin and Sushka, 1988).
To deal with this problem, in October 1979 the Fed instituted a new, so-called
nonborrowed reserve operating procedure.
(8) The Federal Reserve switched from the use of a federal funds rate-operating target to a
nonborrowed reserve target, a change that was associated with sharply increased interest rate volatility.
In this model, open market operations are equivalent to
nonborrowed reserve balances.
For example, Goodfriend (1993, 4) argues that "it is more accurate to refer to the period from October 1979 to October 1982 as one of aggressive federal funds rate targeting than one of
nonborrowed reserve targeting." From a forecasting point of view, Charts 3 and 4 show that including data in this period helps forecast inflation in the 1980s and 1990s; Chart 5 suggests that in dismissing the data simply by a priori reasoning valuable information may be lost.
The Federal Reserve implements monetary policy by influencing short-term interest rates through its control over the supply of
nonborrowed reserve balances held by depository institutions.
In the intermediate case of
nonborrowed reserve targeting (not illustrated), the price level falls by less, reflecting the fact that the money supply function in this case is interest elastic.
The instruments for the 2SLS estimates are the predetermined right-hand-side variables, lagged values of the endogenous right-hand-side variables, and the levels of required reserves and
nonborrowed reserves, both of which are exogenous under
nonborrowed reserve targeting and lagged reserve accounting.
Subtracting the FOMC-specified level of discount window borrowing from this forecast of reserve demand yields the
nonborrowed reserve path, the Desk's prime objective.
(22.) The annual growth rates of employment, M2, and the
nonborrowed reserve ratio as well as inflation, and inflation in sensitive commodities, are calculated as the 12th difference of the logarithms of the levels.
Empirical studies on policy rules tend to split the sample in 1979 or to use data series beginning sometime after October 1982 when the
nonborrowed reserve operating procedure was abandoned.
