There's no puzzle: high nominal rates of the early '80s reflected high expected inflation. It's notorious that, by sharply reducing monetary base growth and shrinking banks' available reserves, Paul Volcker convinced the public that inflation was at last being reined-in. 1/

Had Volcker done the opposite--increasing reserves further--inflation would probably have continued to accelerate, causing the fed funds rate to increase still further.

These effects are quite opposite those from unexpected changes in bank reserves in an environment with low or zero expected inflation.

In fact, the initial effect of Volcker's tightening was a _higher_ fed funds rate. But the longer-run effect, which took hold as people realized that the breaks were being put on bank lending and money growth, was a lower rate reflecting reduced expected inflation.

Hence, far from suggesting that "banks don’t need bank reserves," as @GeorgeGammon supposes, the episode demonstrates just the opposite. (End.)

For "breaks" read "brakes."

@ArnellOErik @StevenHailAus There is no reason why monetary tightening can’t lower already low rates further through the same reduced-Fisher inflation premium channel provided the ZLB doesn’t bind.

@ArnellOErik @StevenHailAus I never said that Fed policy operates directly on inflation expectations except through its capacity to alter actual demand pressure.

@ArnellOErik @StevenHailAus Here is the Darby illustration again:

@Coach_Milly_ You can't ignore the price dimension when speaking of "worthy borrowers." I am a worthy purchaser of a Rolls Royce provided I can find one I can afford!

@ArnellOErik @StevenHailAus @GeorgeGammon On the later switch to fed funds targeting see

@GeorgeGammon @ArnellOErik @StevenHailAus To answer the new question, in a corridor system changes to reserves, e.g. through OMOs, do alter ffr _other things equal_. (“Control” suggests no other determinants, which is untrue.) Since the pics don’t tell us what the other things are up to, they aren’t conclusive.