Short‐term Financial Models at the Federal Reserve Board

Abstract

FINANCIAL MODELS are used extensively by the staff of the Federal ReserveBoard to aid in the analysis of alternative monetary policies.' The purpose of this paper is not to describe these models in detail, but rather to outline the structure of the short-term models and to discuss both how they are used and some problems that we have encountered with them.Two different financial models are used at the Federal Reserve Board: a monthly model of the money market and the money market sector of our quarterly model. A third, a weekly model, has been estimated but used only to analyze special policy questions. The models are structural in the sense that they attempt to isolate demands and supplies of a set of financial assets. While the two models differ somewhat in the assets considered, they both are used to analyze the relationships between the monetary aggregates on the one hand and interest rates and reserves on the other. Any one of these three variables can be assumed exogenous for purposes of simulation. The models are also used to analyze the effects of special policy actions such as the imposition of marginal reserve requirements on CD's. The quarterly model is well known and need not be described here.2 For purposes of this paper, the money market sector of the model is defined to include equations for the public's demand for currency, demand deposits, savings and time deposits, and for CD's along with commercial bank demand for free reserves and their offering rates on savings and time deposits and on CD's. Rates offered on savings deposits by thrift institutions are also included.Given the volume of bank reserves, the sector determines M1, M2, the Treasury bill rate, the CD rate and the average rate offered on savings and thrift accounts.While the money market sector of the quarterly model can be combined with the other sectors of the model to study the implications of various monetary policy alternatives for the full economy, it is also simulated in isolation to determine predicted values for the monetary aggregates and the bill rate for given values for bank reserves, GNP and prices. Both the full model and the sectoral simulations are useful for purposes of policy analyses. In these analyses, either bank reserves or the bill rate or the money stock may be treated as the policy-determined variable.