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How are 0% interest rates 'handing out cash'? I thought bonds worked in the following way: Buy bond at N% interest. When it matures, government pays you origina

by deogeo 7y ago

How are 0% interest rates 'handing out cash'? I thought bonds worked in the following way: Buy bond at N% interest. When it matures, government pays you original price + N%. So 0% would be bond buyers handing cash to the government, no?

whatshisface 7y ago
Fed interbank interest rates aren't the same thing as treasury bond interest rates. Yes, when money is cheap bonds become almost worthless, that can be seen in the market right now. However the cash party isn't for people buying bonds, it's for people with access to the inside track of low-interest money.
- deogeo 7y ago
  So when talking about 'fed interest rates', what is meant is https://en.wikipedia.org/wiki/Federal_funds_rate https://en.wikipedia.org/wiki/Federal_funds_rate ?
  - whatshisface 7y ago
    Yes, that's the interest rate that impacts the money supply (along with other factors) by greasing bank's balance sheets. Treasury interest rates are set by the market, they are whatever they have to be to get people to buy government debt.
nostrademons 7y ago
The Fed operates on a shorter time scale than T-bond maturities. Basically, every night banks are required to make loans to each other to ensure that they meet the reserve requirements on deposits. If they made more loans than they took in deposits, they must borrow on the open market to settle. If they took in more deposits, they can lend. All of these transactions are for extremely short-duration securities (when people talk about repos and money market accounts, they usually mean this). The security itself is simply an agreement to repay $X + interest in the near future, usually the next day. And just like the stock market, there's a market for these: banks with excess deposits offer repos at a variety of interest rates, and banks with excess loans take the best available interest rate, and eventually the market converges on a particular market-clearing rate (the "Fed Funds Rate"). The Fed is a participant in this market. But unlike a normal bank, they aren't subject to reserve requirements. They have an effectively infinite balance sheet consisting of the T-bills etc. that back all the other repo agreements. So when they say that they're setting a Fed Funds Rate of 2.35%, what they really mean is that if banks are fearful that day and want a market-clearing interest rate of 4%, they will sell enough securities in the overnight market that the interest rate goes down to 2.35%. And if banks are greedy and are willing to sell securities at 0%, the Fed will buy enough of them to push the rate back up to 2.35%. This serves to anchor the rate, because if you know that it's going to be in that vicinity, there's no incentive to try and push it higher and lower. It's very much like a stablecoin in the crypto markets. When Facebook pegs the Libra to a basket of currencies or Bitfinex pegs the Tether to $1, they are effectively trying to become a central bank. Decentralized stablecoins like Dai try to distribute that power among a number of ordinary people: the holders of MKR collectively act as a central bank for Dai, with their collateral being ETH rather than T-bills. When you have 0% interest rates, it basically means that banks can borrow as much as they want for free. So it literally is "handing out cash". The actual bonds backing them are held on the Federal Reserve's balance sheet, which is why you might've heard about the Fed's ballooning balance sheet in the last 10 years. The Fed's under no obligation to pay these back, though: its mandate is to keep employment high and inflation low, and so its job is to release just enough of those securities as to soak up inflation. https://www.stlouisfed.org/in-plain-english/a-closer-look-at-open-market-operations https://www.stlouisfed.org/in-plain-english/a-closer-look-at... https://money.howstuffworks.com/fed10.htm https://money.howstuffworks.com/fed10.htm
- twic 7y ago
  * And just like the stock market, there's a market for these: banks with excess deposits offer repos at a variety of interest rates, and banks with excess loans take the best available interest rate, and eventually the market converges on a particular market-clearing rate (the "Fed Funds Rate").* With the small and pedantic correction that the Fed Funds rate doesn't measure repos, because it measures unsecured lending, and repos are secured. It's the Secured Overnight Financing Rate that measures repos. But yes, when the Fed wants to push the Fed Funds rate around, it does it by getting involved in repos - because if banks can borrow from the Fed at 2.4% through a repo, they aren't going to borrow from other banks at 2.41%. You'd think there would be a bit of a spread between the rates, because banks don't have to put up collateral for unsecured borrowing, but in practice there doesn't seem to be.

by deogeo 7y ago

whatshisface 7y ago

Fed interbank interest rates aren't the same thing as treasury bond interest rates. Yes, when money is cheap bonds become almost worthless, that can be seen in the market right now. However the cash party isn't for people buying bonds, it's for people with access to the inside track of low-interest money.

deogeo 7y ago
So when talking about 'fed interest rates', what is meant is https://en.wikipedia.org/wiki/Federal_funds_rate https://en.wikipedia.org/wiki/Federal_funds_rate ?
- whatshisface 7y ago
  Yes, that's the interest rate that impacts the money supply (along with other factors) by greasing bank's balance sheets. Treasury interest rates are set by the market, they are whatever they have to be to get people to buy government debt.

nostrademons 7y ago

The Fed operates on a shorter time scale than T-bond maturities. Basically, every night banks are required to make loans to each other to ensure that they meet the reserve requirements on deposits. If they made more loans than they took in deposits, they must borrow on the open market to settle. If they took in more deposits, they can lend. All of these transactions are for extremely short-duration securities (when people talk about repos and money market accounts, they usually mean this). The security itself is simply an agreement to repay $X + interest in the near future, usually the next day. And just like the stock market, there's a market for these: banks with excess deposits offer repos at a variety of interest rates, and banks with excess loans take the best available interest rate, and eventually the market converges on a particular market-clearing rate (the "Fed Funds Rate"). The Fed is a participant in this market. But unlike a normal bank, they aren't subject to reserve requirements. They have an effectively infinite balance sheet consisting of the T-bills etc. that back all the other repo agreements. So when they say that they're setting a Fed Funds Rate of 2.35%, what they really mean is that if banks are fearful that day and want a market-clearing interest rate of 4%, they will sell enough securities in the overnight market that the interest rate goes down to 2.35%. And if banks are greedy and are willing to sell securities at 0%, the Fed will buy enough of them to push the rate back up to 2.35%. This serves to anchor the rate, because if you know that it's going to be in that vicinity, there's no incentive to try and push it higher and lower. It's very much like a stablecoin in the crypto markets. When Facebook pegs the Libra to a basket of currencies or Bitfinex pegs the Tether to $1, they are effectively trying to become a central bank. Decentralized stablecoins like Dai try to distribute that power among a number of ordinary people: the holders of MKR collectively act as a central bank for Dai, with their collateral being ETH rather than T-bills. When you have 0% interest rates, it basically means that banks can borrow as much as they want for free. So it literally is "handing out cash". The actual bonds backing them are held on the Federal Reserve's balance sheet, which is why you might've heard about the Fed's ballooning balance sheet in the last 10 years. The Fed's under no obligation to pay these back, though: its mandate is to keep employment high and inflation low, and so its job is to release just enough of those securities as to soak up inflation. https://www.stlouisfed.org/in-plain-english/a-closer-look-at-open-market-operations https://www.stlouisfed.org/in-plain-english/a-closer-look-at... https://money.howstuffworks.com/fed10.htm https://money.howstuffworks.com/fed10.htm

twic 7y ago
* And just like the stock market, there's a market for these: banks with excess deposits offer repos at a variety of interest rates, and banks with excess loans take the best available interest rate, and eventually the market converges on a particular market-clearing rate (the "Fed Funds Rate").* With the small and pedantic correction that the Fed Funds rate doesn't measure repos, because it measures unsecured lending, and repos are secured. It's the Secured Overnight Financing Rate that measures repos. But yes, when the Fed wants to push the Fed Funds rate around, it does it by getting involved in repos - because if banks can borrow from the Fed at 2.4% through a repo, they aren't going to borrow from other banks at 2.41%. You'd think there would be a bit of a spread between the rates, because banks don't have to put up collateral for unsecured borrowing, but in practice there doesn't seem to be.