Let's Close the Gap: Revising Teaching Materials to Reflect How the Federal Reserve Implements Monetary Policy

Abstract

The topic of the Federal Reserve’s (the Fed’s) implementation of monetary policy has a significant presence in economics textbooks as well as standards and guidelines for economics instruction. This presence likely reflects the fact that it is the implementation framework that helps ensure that the Fed’s desired level of its policy interest rate is transmitted to financial markets, which helps it steer the economy toward the Congressional dual mandate of maximum employment and price stability. Over the past decade or so, the Fed has purposefully shifted the way it implements monetary policy to an environment with ample reserves in the banking system, and it has introduced new policy tools along the way. This paper shows that, unfortunately, many teaching resources are not in sync with the Fed’s current framework. We review six, 2020 or 2021 edition, principles of economics textbooks, and we find they vary greatly in their coverage of the concepts associated with the way the Fed implements policy today and in the longer run. We provide recommendations on how the authors can improve the next editions of their textbooks. We also review standards and guidelines used by secondaryschool educators. All of these are out of date, and we provide proposals for how these materials can be updated.

Teaching Monetary Policy with Ample Reserves

“…6 And, for those that teach AP courses, your students are now being tested on the basic concepts. Teaching this material may be a difficult task given that the National Voluntary Content Standard in Economics (Ihrig & Wolla, 2022a), textbooks (Ihrig & Wolla, 2022b), and many other teaching resources (Ihrig & Wolla, 2020b) still reflect the limited reserves regime. This newness and lack of resources has led to many questions about how to introduce the ample reserves regime into the classroom.…”

Market Reactions to the Federal Reserve's Balance Sheet Normalization Plans

“…The implementation of monetary policy changed dramatically in the wake of the global financial crisis and the authorization that Congress gave the Fed to pay interest on reserves. In contrast to the old system of monetary policy implementation with scarce reserves, which is unfortunately still often taught in intro macroeconomics classes (Ihrig and Wolla 2020), the Fed now sets the interest rate on reserves which puts a floor on banks' reserve demand, and then the Fed supplies an amount of reserves that ensures that equilibrium is always on the flat part of the reserve demand curve. Since only depository institutions are eligible to receive interest on reserves, it turns out that this can lead to segmentation whereby short-term interest rates are generally well below the level of interest on reserves.…”

The Extent and Consequences of Federal Reserve Balance Sheet Shrinkage

“…The implementation of monetary policy changed dramatically in the wake of the global financial crisis and the authorization that Congress gave the Fed to pay interest on reserves. In contrast to the old system of monetary policy implementation with scarce reserves, which is unfortunately still often taught in intro macroeconomics classes (Ihrig and Wolla 2020), the Fed now sets the interest rate on reserves which puts a floor on banks' reserve demand, and then the Fed supplies an amount of reserves that ensures that equilibrium is always on the flat part of the reserve demand curve. Since only depository institutions are eligible to receive interest on reserves, it turns out that this can lead to segmentation whereby short-term interest rates are generally well below the level of interest on reserves.…”