![]() The Fed funds rate is the interest rate on overnight loans of reserve balances between banks.The resulting financial market rates influence price levels and employment demands in the economy, the two traditional mandates of the Fed. Interest on reserve balances (IORB) is the primary tool the Fed now uses to influence market interest rates, such as the deposit and loan rates that commercial banks offer their customers and in turn the spending and savings decisions of households and businesses.“Were,” because this requirement was reduced, and then eliminated, after the 2008 financial crisis and the shift to what the Fed now calls an “ample reserve regime.” Reserve requirements were the deposits that the Fed required a commercial bank to hold at the Fed.Reserve balances are the deposits that a commercial bank holds in its account at the Fed held in its regional Federal Reserve Bank. ![]() There are some very large financial entities that do both commercial and investment banking, e.g., JPMorgan Chase and Bank of America. Nevertheless, the fed helped to rescue some of the largest investment banks during the financial crisis of 2007–2008. Investment banks are not subject to the tools of the Fed. There are also investment banks, which buy and sell stocks, bonds, and other assets. Commercial banks, what most people think of when they hear the word “bank,” accept deposits and make loans they safeguard assets deposited with them because they are backed up by the Federal Deposit Insurance Corporation (FDIC).The face or par value of a bond is the amount that will be paid to the holder of the bond at maturity, the date when the issuer must repay. Bonds are promissory notes issued by both private entities, such as corporations, and governments, to raise money.So, let’s take a closer look at what happened to the Fed’s old tools, how the Fed puts its new tool to work, and how the Fed’s policies prop up today’s economy, which is marred by financial excesses and ever-worsening wealth inequality. Unless you subscribe to Federal Reserve publications, this is all probably news to you. Even the Fed now recognizes the financial sector’s dominance of today’s economy-aka “financialization.” The Fed’s statement on monetary policy strategy, adopted in January 2012 and reaffirmed this January, reads that, “achieving maximum employment and price stability depends on a stable financial system,” thus making maintaining financial stability effectively a third mandate of the Fed. And with its new tool and repurposed old tools, the Fed was freed up to turn the liquidity spigot to full blast to stabilize a financial sector that is increasingly plagued by crises. ![]() Those tools were unable to stabilize a failing financial system during the Great Recession of 2007–2009, or to reinvigorate the sluggish economy in the decade that followed, or to cope with the failing economy during the Covid-19 pandemic during this decade.ĭuring the Great Recession, the Fed turned to a new tool: the interest rate the Fed pays on the reserves (read: money) that commercial banks deposit at the Fed. Second, for over a decade, the Fed has no longer used those three tools to conduct monetary policy, at least not in the way you might have learned about in a macroeconomics course. First, historically the Fed has put price stability, which favors employers and investors, ahead of promoting maximum employment, which would increase workers’ bargaining power and push up their wages. Much of that, however, was never true in practice. And you then recite the catechism that the Fed uses three tools of monetary policy-the reserve requirement, the discount rate, and open market operations-to expand or contract the money supply and lower or raise interest rates. In any introductory macroeconomics course in college or high school, you learn that the Federal Reserve Board (the central bank of the United States, commonly referred to as “the Fed”) uses monetary policy to carry out its dual mandate of promoting high employment and ensuring price stability. ![]()
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