Macroeconomics
Targeting the federal funds rate is one of the primary tools used by the Fedtoimplementits monetary policy. The Fed sets a target range for this rate and uses various open market operations to achieve it.
How the policy or federal funds rate works: ➔ When the Fed sets a target for the federal funds rate, it directly affects the interest rates at which banks borrow and lend in the federal funds market. If the targetrateislowerthanthe prevailing rate, banks will seek to borrow more reserves at the lower rate. Conversely, if the targetrateishigher,bankswillbelesswillingtolendreservesatalowerrate.Thismechanism influences the supply and demand for money in the money market. ➔ Changesinthefederalfundsrateinfluencetheoverallinterestrateenvironmentintheeconomy. When the Fed lowers the federal funds rate target, it tends to lead to lowerinterestrateson various types of loans, including mortgages and business loans. Lower interest rates can stimulate borrowing and spending by both consumers and businesses, which, in turn, boosts aggregate demand.
➔ During periods of economic slowdown or recession, the Fed might lower the federal funds rate to encourage borrowing and investment. Conversely, during periods of high inflation or excessive economic growth, the Fed might raise the federal funds rate to cool down the economy and combat inflationary pressures. 3. InterestonReserves(IOR): TheFedhasrecentlyintroduced
thisas anewtoolofmonetarypolicy associatedwiththeamplereservesbankingsystem.Itis asafeandguaranteed interestpaidtocommercialbanksonthedeposits(reserves)theyhold within the Fed . When the Fed pays interest on reserves, it encourages commercial banks to keep more money on reserve andlendlessout,whichhelpsinthecreationofamplereserves banking systems.
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