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 18 July 2016

The Fed And Interest Rates: A Floor With A Subfloor - Part 2 Of 2

from the St Louis Fed

Yesterday's post explained that the Federal Reserve has moved from a channel system to a floor system regarding the conduct of monetary policy. Today's post will explain how reality has differed from theory for conducting policy and what the Fed's solution has been.

Vice President and Economist Stephen Williamson explained that given the large stock of reserves outstanding, the Fed should, in principle, be able to target the federal funds rate (or the interest rate banks charge when they lend to each other overnight) by setting the interest rate on excess reserves (IOER).

However, Williamson noted that the IOER was set at 0.25 percent from late 2008 through December 2015, while the fed funds rate has generally been 5 to 20 basis points lower than the IOER since early 2009. He wrote: "This difference between the IOER and the fed funds rate is typically ascribed to costs for commercial banks associated with borrowing on the fed funds market."

Monetary Policy and Liftoff

Williamson noted that the difference between the IOER and the fed funds rate was a concern as the Fed discussed "liftoff," or a departure from the zero interest rate policy it had followed since late 2008. He wrote: "Could the Fed expect that the fed funds rate would increase along with the IOER if the Fed attempted to control the fed funds rate only through increases in the IOER?"

A Floor System with a Subfloor

Williamson noted that "the solution adopted by the Fed is unique in central banking - a floor system with a subfloor." The subfloor is dictated by the rate on what are called overnight reverse repurchase agreements, or ON-RRPs.

With ON-RRPs, financial institutions lend to the Fed, just like with reserves held at the Fed. The difference is that the Fed puts up securities as collateral.

Williamson noted that the idea behind the floor-with-subfloor system is that the Fed sets an ON-RRP rate in addition to the discount rate and IOER. He wrote: "The ON-RRP rate is set below the IOER, and then policy is announced as a target range for the fed funds rate, with the top of the range given by the IOER and the bottom of the range determined by the ON-RRP rate. Thus, the IOER sets the floor, and the ON-RRP rate sets the subfloor."

Does the Floor-with-Subfloor System Work?

At its Dec. 16 meeting, the Federal Open Market Committee:

  • Increased the fed funds rate target range from 0-0.25 percent to 0.25-0.50 percent

  • Set the discount rate at 1.0 percent

  • Set the IOER at 0.50 percent

  • Set the ON-RRP rate at 0.25 percent

Williamson noted that, in the few weeks that followed, the average daily fed funds rate was typically within a range of 0.35-0.37 percent, with one exception. He wrote: "Thus, in terms of results, the Fed has been successful in controlling the fed funds rate within the 0.25-0.50 percent range."

Year-End Exception

The one exception was on Dec. 31, when the average fed funds rate was 0.20 percent. At the same time, the value of ON-RRPs outstanding rose to $475 billion from just $105 billion two weeks prior. Williamson noted that the key is the date, "which is important because at this time financial reporting takes place and financial institutions want to have their balance sheets appear as favorable as possible to their shareholders and regulators."

As Williamson put it, lending to the Fed via ON-RRPs is essentially riskless, while lending on the fed funds market entails some risk. "Therefore, we might expect that, on Dec. 31, lenders in the overnight market would shift their activity from the fed funds market to the ON-RRP market, as this would reduce risk on their balance sheets. Sure enough, we saw a large increase in ON-RRP activity on Dec. 31."

Additional Resources


Views expressed are not necessarily those of the Federal Reserve Bank of St. Louis or of the Federal Reserve System.


>>>>> 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.  As the internet is a "war zone" of trolls, hackers and spammers - Econintersect must balance its defences against ease of commenting.  We have joined with Livefyre to manage our comment streams.

To comment, using Livefyre just click the "Sign In" button at the top-left corner of the comment box below. You can create a commenting account using your favorite social network such as Twitter, Facebook, Google+, LinkedIn or Open ID - or open a Livefyre account using your email address.

You can also comment using Facebook directly using he comment block below.

Econintersect Contributors


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
Main Home
Analysis Blog
From Money Controlling People to People Controlling Money
Rising Tide Does Not Lift All Ships
News Blog
Infographic Of The Day: The Most Popular Jobs In A Decade
Early And Late Cycle Verdicts Are Baseless
The Surprising Divergence Of Employment And Capacity Utilization
The Slump In Undocumented Immigration To The United States
U.S. Productivity Growth Flowing Downstream
Your Light Bulbs Could Be Playing Havoc With Your Health - Here's Why
Mentions Of Trump And Clinton In Hip Hop Lyrics
Salary Is The Most Important Job Criterion
Can Switch Replicate Nintendos Past Success
The Numbers Behind The Zumwalt
Docking A Huge Cruise Ship Is More Complicated Than You Think
New Seasonal Outlook Updates from NOAA and JAMSTEC - Let's Compare Them.
Infographic Of The Day: Driving Into A Battery Powered Future
Investing Blog
FinTech Is Taking A Bite Out Of Banks
Options Early Assignment - Should You Worry?
Opinion Blog
The Beer Goggles Stock Market
US 2016 Election: Will US-China Relations Change
Precious Metals Blog
Preparing For Post-Election Social Unrest
Live Markets
21Oct2016 Market Close: Major US Indexes Close Flat On Low Volume, Crude Prices Resume Climb, US Dollar Stabilizes In Mid 98 Handle, Yes, Most Investors Are Worried Which Way This Market Will Go
Amazon Books & More

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

Crowdfunding ....



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


Asia / Pacific
Middle East / Africa
USA Government

RSS Feeds / Social Media

Combined Econintersect Feed

Free Newsletter

Marketplace - Books & More

Economic Forecast

Content Contribution



  Top Economics Site Contributor TalkMarkets Contributor Finance Blogs Free PageRank Checker Active Search Results Google+

This Web Page by Steven Hansen ---- Copyright 2010 - 2016 Econintersect LLC - all rights reserved