3
$\begingroup$

The Fed has a number of tools/targets with which they manage monetary policy. I'm looking to refine a concise summary of them and looking for guidance/correction/validation.

Think I understand these first three. Please correct me if I'm wrong:

  1. Open Market Operations: The Federal Open Market Committee (FOMC) will often instruct the Federal Reserve Bank of New York to engage in open market operations (buying and selling of US securities) to influence interest rates. Movement at all maturities on the yield curve can reflect such operations; the Fed has been known to try and alter the shape/slope of the curve.
  2. The Discount Window: offers various types of credit at the discount rate; designed for times of stress; rates are high (penalty rates - see Bagehot's Dictum); use of discount window credit may spark regulator investigation. Discount Window credit is typically overnight (primary/secondary) or less than 9 months in the case of seasonal loans. Changes in discount rate only affects the short end of the yield curve.

  3. The Fed Fund rate: overnight rate at which reserve balances, held by banks at the fed can be lent to each other. This rate is calculated from market transactions. The Fed determines their FF rate target and use open market operations to move the Fed Funds rate toward a particular level. Whilst the Fed Fund rate is an overnight rate, it can be related to longer term movements on the yield curve (1-month treasury bill for example) but there are differences; notably the Fed Funds rate, being a market rate, does vary, while the yield on a 1-month Treasury is effectively fixed at the time of purchase. The relationship between the expected values of a fixed rate and a floating rate is expressed through Overnight Indexed Swap values, and 1-month OIS on the Fed Funds rate is the best direct indication of the expected value of compounded overnight borrowing in the Fed Funds market.

I'm looking for further confirmation/understanding no the next two:

  1. The reverse repo program, which enables it to set a floor under short-term secured borrowing rates. This makes sense: reverse repo = sell security, collect payment from bank, reduce their fed reserve balance, decrease supply of money in the system and put upwards pressure on the federal funds rate for example. Is this logic correct?

  2. The interest rate on excess reserves (IOER); from comments on my prior question, I understand that this rate sets the ceiling for fed funds. IOER = interest paid on balances above the required level; how does that set a ceiling? Sounds more like a floor; for a bank to lend its excess reserves, they would want a higher rate than the IOER?

This is a follow on from part one which was posted here.

$\endgroup$
1
$\begingroup$

According to money market expert Scott Skyrm:

quote

The FRRP provides a floor to the market because as overnight rates approach the FRRP rate, more volume is executed at the facility and more collateral is added to the market, removing cash.

The IOER acts as a ceiling in the overnight market by adding cash, though indirectly. When market rates like fed funds and GC Repo trade above the IOER, banks will move cash out of Excess Reserves and into fed funds or GC Repo to maximize their overnight investments, effectively driving those rates lower. Therefore, it’s important to note, the IOER is an effective upper rate band, but only while banks have significant Excess Reserves stored at the Fed.

End quote

$\endgroup$

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.