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> I mean how else the current 2.00-2.25% rate is forced onto the financial system? Traditionally, Fed used open market operations to target the fed funds rate.

> I mean how else the current 2.00-2.25% rate is forced onto the financial system? Traditionally, Fed used open market operations to target the fed funds rate. This entailed either buying/selling treasuries or conducting repo operations (as was done here). This was a corridor system, as banks could earn no less than 0% interest keeping reserves on the Fed's balance sheet (no negative interest) and could finance at a cost no higher than the discount rate in which banks borrowed directly from the Fed's discount window (this, however, sent a very negative signal to the market). For the past decade, the Fed has relied on interest on excess reserves (IOER) to target the fed funds rate, a policy known as a floor system. Here, banks earn a given interest rate on reserves kept on the fed's balance sheet. The floor system theoretically ensures short term rates do not drop below the IOER rate (although it is not always the case). This does not entail engaging in open market operations. > Why else would anyone even care about what the FED rate is? All dollar interest rates are impacted in one way or another by the fed funds rate. The strength of the dollar is also impacted by the fed funds rate, as it may become more or less attractive to keep balances in the US. The floor system currently employed makes it less attractive for banks to use excess reserves to make loans, as the risk free rate (on the fed balance sheet) is greater. This diminishes the money multiplier effect that banks have. Additionally, some foreign institutions are able to keep money on the fed's balance sheet, helping them avoid negative interest rates. Again, this disincentivizes them from making loans and also undermines monetary policy implemented by their local central banks. Finally, some currencies have a USD peg (e.g. HKD). These pegs effectively import Federal Reserve monetary policy (to help mitigate the risk of currency crises) which affects the local economies.

H8crilA 7y ago
It sounds like you agree that this is the mechanism of choice used to push down overnight interbank interest rates to keep them in line with the federal funds rate. IOER, by design, provides just a floor. Discount rate is, by design, quite a bit higher than the fed funds rate, and is only tapped for credit in emergencies. Also this is what Wikipedia says on the topic: > The (effective) federal funds rate is achieved through open market operations at the Domestic Trading Desk at the Federal Reserve Bank of New York which deals primarily in domestic securities (U.S. Treasury and federal agencies' securities). https://en.wikipedia.org/wiki/Federal_funds_rate#Comparison_with_LIBOR https://en.wikipedia.org/wiki/Federal_funds_rate#Comparison_... So, WAI. We just haven't seen cash injection through this mechanism in a while.
- nickles 7y ago
  > Discount rate is, by design, quite a bit higher than the fed funds rate, and is only tapped for credit in emergencies. That's right. Open market operations were traditionally used to target the fed funds rate. The discount window does serve as the upper bound though in extreme cases. Typically, reserves would be loaned overnight between banks on the fed funds market. This market has been decimated by the floor system. > IOER, by design, provides just a floor. In theory, yes. It has also acted as a ceiling. Not all institutions with access to Fed's balance sheet are able to receive IOER (e.g. GSE's). These entities loan the money to banks overnight at a rate below IOER. The banks then earn IOER on that money. This arbitrage can lead to an effective fed funds rate below IOER.
  - H8crilA 7y ago
    > This market has been decimated by the floor system. You mean there has been so much cash around that nobody really needed to get cash via the fed funds market, for quite a while? It does seem like the spread between fed funds and IOER is generally just a few bp, maybe even 1bp sometimes, which I guess is where the "ceiling" you were talking about comes from: https://fred.stlouisfed.org/series/IOER https://fred.stlouisfed.org/series/IOER https://fred.stlouisfed.org/series/FEDFUNDS https://fred.stlouisfed.org/series/FEDFUNDS
    - nickles 7y ago
      > You mean there has been so much cash around that nobody really needed to get cash via the fed funds market, for quite a while? Prior to IOER, banks needed to lend money on the fed funds market to earn interest on any excess reserves. Doing so exposed them to the credit risk of their counterparty. Once it became possible to earn IOER risk free, banks had no incentive to expose themselves to the credit risk. Since banks (of all sizes) could not then rely on being able to access the fed funds market for liquidity, it became necessary for them to keep more reserves at the Fed. Perversely, as the quantity of reserves held at the Fed increased, interbank lending decreased (for more detail, see [0] pages 33-39). > It does seem like the spread between fed funds and IOER is generally just a few bp Until recently, it looks like the spread has been roughly 5-17bps [1]. For a floor system, it seems rather odd that this would exist at all, especially for a period of a decade (see [0] pages 18-19). [0] https://www.cato.org/sites/cato.org/files/pubs/pdf/working-paper-50-updated-3.pdf https://www.cato.org/sites/cato.org/files/pubs/pdf/working-p... [1] https://imgur.com/n3R366c https://imgur.com/n3R366c
cm2187 7y ago
This is all true. But it is worth noting that the Fed has increasingly tried to apply untraditional monetary policies. For instance with operation twist, the Fed was trying to control long term rate with bond buying. Also I believe they also keep an eye on repos, not the least because it will be the basis for SOFR, the replacement of LIBOR.

H8crilA 7y ago

It sounds like you agree that this is the mechanism of choice used to push down overnight interbank interest rates to keep them in line with the federal funds rate. IOER, by design, provides just a floor. Discount rate is, by design, quite a bit higher than the fed funds rate, and is only tapped for credit in emergencies. Also this is what Wikipedia says on the topic: > The (effective) federal funds rate is achieved through open market operations at the Domestic Trading Desk at the Federal Reserve Bank of New York which deals primarily in domestic securities (U.S. Treasury and federal agencies' securities). https://en.wikipedia.org/wiki/Federal_funds_rate#Comparison_with_LIBOR https://en.wikipedia.org/wiki/Federal_funds_rate#Comparison_... So, WAI. We just haven't seen cash injection through this mechanism in a while.

nickles 7y ago
> Discount rate is, by design, quite a bit higher than the fed funds rate, and is only tapped for credit in emergencies. That's right. Open market operations were traditionally used to target the fed funds rate. The discount window does serve as the upper bound though in extreme cases. Typically, reserves would be loaned overnight between banks on the fed funds market. This market has been decimated by the floor system. > IOER, by design, provides just a floor. In theory, yes. It has also acted as a ceiling. Not all institutions with access to Fed's balance sheet are able to receive IOER (e.g. GSE's). These entities loan the money to banks overnight at a rate below IOER. The banks then earn IOER on that money. This arbitrage can lead to an effective fed funds rate below IOER.
- H8crilA 7y ago
  > This market has been decimated by the floor system. You mean there has been so much cash around that nobody really needed to get cash via the fed funds market, for quite a while? It does seem like the spread between fed funds and IOER is generally just a few bp, maybe even 1bp sometimes, which I guess is where the "ceiling" you were talking about comes from: https://fred.stlouisfed.org/series/IOER https://fred.stlouisfed.org/series/IOER https://fred.stlouisfed.org/series/FEDFUNDS https://fred.stlouisfed.org/series/FEDFUNDS
  - nickles 7y ago
    > You mean there has been so much cash around that nobody really needed to get cash via the fed funds market, for quite a while? Prior to IOER, banks needed to lend money on the fed funds market to earn interest on any excess reserves. Doing so exposed them to the credit risk of their counterparty. Once it became possible to earn IOER risk free, banks had no incentive to expose themselves to the credit risk. Since banks (of all sizes) could not then rely on being able to access the fed funds market for liquidity, it became necessary for them to keep more reserves at the Fed. Perversely, as the quantity of reserves held at the Fed increased, interbank lending decreased (for more detail, see [0] pages 33-39). > It does seem like the spread between fed funds and IOER is generally just a few bp Until recently, it looks like the spread has been roughly 5-17bps [1]. For a floor system, it seems rather odd that this would exist at all, especially for a period of a decade (see [0] pages 18-19). [0] https://www.cato.org/sites/cato.org/files/pubs/pdf/working-paper-50-updated-3.pdf https://www.cato.org/sites/cato.org/files/pubs/pdf/working-p... [1] https://imgur.com/n3R366c https://imgur.com/n3R366c

cm2187 7y ago

This is all true. But it is worth noting that the Fed has increasingly tried to apply untraditional monetary policies. For instance with operation twist, the Fed was trying to control long term rate with bond buying. Also I believe they also keep an eye on repos, not the least because it will be the basis for SOFR, the replacement of LIBOR.