trade rules and regulations and in economic policies
abroad can lower or raise the contribution of the exter-
nal sector to the U.S. economy.
The FOMC also must estimate when, and to
what extent, its own policy actions will affect money,
credit, interest rates, business developments and prices.
Since the state of knowledge about the way the econo-
my works is quite imperfect, policymakers’ understand-
ing of the effects of various influences, including the
effect of monetary policy, is far from certain. Moreover,
the working of the economy changes over time, leading
to changes in its response to policy and nonpolicy fac-
tors. On top of all these difficulties, policymakers do not
have up-to-the-minute, reliable information about the
economy, because of lags in the collection and publica-
tion of data. Even preliminary published data are fre-
quently subject to significant errors that become evident
in subsequent revisions.
In all of this, there is no escape from forecasting
and from using judgment to deal with the uncertainties
of data and the policy process. Indeed, monetary policy
formulation is not a simple technical matter; it is clearly
an art in that it greatly depends on experience, expertise
and judgment.
Operational Approaches
Determining the appropriate reserve market condi-
tions—that is, the desired degree of monetary policy
66 // UUnnddeerrssttaannddiinngg OOppeenn MMaarrkkeett OOppeerraattiioonnss
restraint—also is very complicated. In choosing an oper-
ating strategy, the FOMC attempts to achieve a desired
degree of monetary policy restraint, ease or tightness, by
focusing on the reserve supply relative to demand, and
the associated level of the federal funds rate. The
Domestic Open Market Desk at the Federal Reserve
Bank of New York can come reasonably close to meet-
ing short-term objectives for nonborrowed reserves—
supply of reserves excluding discount window borrow-
ing. The contemplated reserve levels are based, of
course, on the FOMC’s desire to induce short-run mon-
etary and financial conditions that will help to achieve
policy goals for the economy.
In principle, the FOMC can aim for direct control
of the quantity of reserves by not accommodating
observed fluctuations in the demand for reserves.
However, this will result in free movements in the federal
funds rate. Alternatively, the FOMC can control the fed-
eral funds rate by adjusting the supply of reserves to
meet all changes in the demand for reserves; this will
allow the quantity of reserves to vary freely. Over the
years, the actual approach has been adapted to chang-
ing circumstances. Sometimes the emphasis has been
on controlling the quantity of reserves; other times, the
federal funds rate.
While the FOMC generally has not aimed at pre-
cise control of the quantity of reserves, the operating
strategy from October 1979 to late 1982 was closely