econintersect.com
       
  

FREE NEWSLETTER: Econintersect sends a nightly newsletter highlighting news events of the day, and providing a summary of new articles posted on the website. Econintersect will not sell or pass your email address to others per our privacy policy. You can cancel this subscription at any time by selecting the unsubscribing link in the footer of each email.



posted on 17 July 2016

The Fed, Interest Rates And Monetary Policy - Part 1 Of 2

from the St Louis Fed

Many people know that the Federal Reserve affects interest rates. However, many may not know exactly how the Fed does that. An article inThe Regional Economist discusses the various interest rates the Fed sets.

Vice President and Economist Stephen Williamson discussed three interest rates the Fed sets, either as a target or by administrative fiat:

  • The federal funds rate, which is the interest rate financial institutions charge when they lend to other institutions overnight

  • The discount rate, which is the interest rate charged by the Fed when it lends to commercial banks in its role as lender of last resort

  • The interest paid by the Fed on reserves held by banks, which are essentially checking accounts for financial institutions

Monetary Policy and the Channel System

Williamson explained that, prior to the financial crisis, the Fed conducted monetary policy using what economists call a channel system. The discount rate was the upper limit, the interest rate on reserves was the lower limit, and the fed funds rate was targeted in between. (It should be noted that the Fed couldn't pay interest on reserves until late 2008, so the lower limit was zero.)

As Williamson pointed out, if the fed funds rate went above the discount rate, then institutions could borrow from the Fed more cheaply than from other institutions. Similarly, if the fed funds rate went below the interest paid on reserves, no bank would lend to another when it could get a higher return by lending to the Fed.

The Move to the Floor System

According to Williamson, the details of how the Fed conducts monetary policy changed in important ways between 2007 and now. In particular, two things happened:

  • As previously mentioned, the Fed began paying interest on reserves.

  • The Fed purchased lots of assets (such as U.S. Treasuries and agency mortgage-backed securities) through quantitative easing, which led to a large increase in the stock of reserves.

He noted that the large stock of reserves implies that monetary policy works within a floor system now, rather than a channel system, and that the interest rate on excess reserves (IOER) plays a key role. In principle, the Fed could achieve its fed funds rate target by simply setting the IOER.

He wrote: "If the fed funds rate were lower than the IOER, then banks would be able to make a profit from borrowing on the fed funds market and lending to the Fed at the IOER, thus forcing up the fed funds rate. If the fed funds rate were higher than the IOER, then a bank wanting to lend would earn more interest on the fed funds market than by lending to the Fed at the IOER. The large demand for fed funds would then force the fed funds rate down."

However, theory and reality aren't agreeing. Tomorrow's post will examine what has actually happened and describe the adopted solution: a floor with a subfloor.

Additional Resources

>>>>> Scroll down to view and make comments <<<<<<

Click here for Historical News Post Listing










Make a Comment

Econintersect wants your comments, data and opinion on the articles posted. You can also comment using Facebook directly using he comment block below.




Econintersect Contributors


search_box

Print this page or create a PDF file of this page
Print Friendly and PDF


The growing use of ad blocking software is creating a shortfall in covering our fixed expenses. Please consider a donation to Econintersect to allow continuing output of quality and balanced financial and economic news and analysis.


Take a look at what is going on inside of Econintersect.com
Main Home
Analysis Blog
Why Long-Run Theories of Profit and Accumulation Fall Short
Brexit - Who Wins and Loses
News Blog
Understanding The Downward Trend In Labor Income Shares
Why Renegotiating NAFTA Could Disrupt Supply Chains
Public Relations Nightmares
Catch Me If You Can
U.S. Consumer Debt Rises Overall, Housing Debt Drops
Infographic Of The Day: Graphene Is The Game-Changing Material Of The Future
Early Headlines: CB Bal. Sheets Still Growing, GOP Doing Too Much, May Threw Ulster Under Bus, French Election, China Vs. Pollution, Venzuela Gave To Trump Inaug., And More
NOAA and JAMSTEC Issue Seasonal Updates - Winter in Doubt
Over 200,000 People Have Been Displaced From Mosul
Heat From The Atlantic Ocean Is Melting Arctic Sea Ice Further Eastwards Than Ever Before
Number Of Americans Without Healthcare Insurance Has Dropped
What We Read Today 22 April 2017
B-2 Spirit Stealth Bomber In Action
Investing Blog
The Week Ahead: Build That Wall!
How To Trade Earnings Announcements
Opinion Blog
What Does The Strong Q1 Growth Mean For China?
Marx, Orwell And State-Cartel Socialism
Precious Metals Blog
Three Gold Plays For The New Era Of Chaos
Live Markets
21Apr2017 Market Close: US Stocks Slipped Moderately, WTI Crude Slips On Renewed Concerns Of Increasing U.S. Production, Industrial Businesses' Cash Outflows Concern Investors
Amazon Books & More






.... and keep up with economic news using our dynamic economic newspapers with the largest international coverage on the internet
Asia / Pacific
Europe
Middle East / Africa
Americas
USA Government































 navigate econintersect.com

Blogs

Analysis Blog
News Blog
Investing Blog
Opinion Blog
Precious Metals Blog
Markets Blog
Video of the Day
Weather

Newspapers

Asia / Pacific
Europe
Middle East / Africa
Americas
USA Government
     

RSS Feeds / Social Media

Combined Econintersect Feed
Google+
Facebook
Twitter
Digg

Free Newsletter

Marketplace - Books & More

Economic Forecast

Content Contribution

Contact

About

  Top Economics Site

Investing.com Contributor TalkMarkets Contributor Finance Blogs Free PageRank Checker Active Search Results Google+

This Web Page by Steven Hansen ---- Copyright 2010 - 2017 Econintersect LLC - all rights reserved