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First I have heard of this and quite interesting to learn. Could you explain the difference ? Does this mean they are going to implement the rate increase some

First I have heard of this and quite interesting to learn. Could you explain the difference ? Does this mean they are going to implement the rate increase some point in future ala target ?

blawson 5y ago
Not GP, but I don't think there's an actual "rate" as such - it's the actions the Fed takes to balance prices such that it falls within their target: https://www.newyorkfed.org/markets/reference-rates/effr https://www.newyorkfed.org/markets/reference-rates/effr
monktastic1 5y ago
As another reply indicated, the Fed doesn't actually set interest rates. That's a common misconception. Instead they purchase and sell treasuries to member banks, such that those banks' balance sheets change in such a way as to make money more or less expensive to trade amongst themselves, which has knock-on effects for consumers. On the other hand, since there's no longer a reserve requirement since the start of covid, the mechanism that causes banks to have to borrow from each other (to meet the nightly reserve requirement, historically) is much less clear to me. Hopefully an economist can chime in.
- drexlspivey 5y ago
  > As another reply indicated, the Fed doesn't actually set interest rates. That's a common misconception. The FED absolutely sets the interest rates by controlling the federal reserve rate which is the interaste rate paid to banks every day for their deposits with the FED
  - monktastic1 5y ago
    The Fed (not FED, BTW) doesn't "set" the rates, but has policies (including IORB, or what you call the federal reserve rate) which guide the markets to arrive at their target. Maybe that's a small distinction, but I think it helps OP, because I labored under the same confusion for a while.
    - nickles 5y ago
      > The Fed (not FED, BTW) doesn't "set" the rates, but has policies (including IORB, or what you call the federal reserve rate) The Fed does explicitly set certain interest rates. IORB is an interest rate that gets paid out every single day to market participants. “Federal reserve rate” does not exist; what you’re probably referring to is the fed funds rate. The Fed sets a target range for this, and, if the effective fed funds rate does not stay within the target corridor, the Fed will conduct open market operations to push it there.
      - monktastic1 5y ago
        "Federal reserve rate" is not my term. My parent comment coined it and defined it as "the interaste (sic) rate paid to banks every day for their deposits with the FED", which is the IORB. I appreciate the thorough and accurate response you gave (and which I learned from). The distinction I've been trying to make is that the Fed has no mechanism to enforce the rate banks offer to each other or to consumers -- as in, there's no legal enforcement anywhere. Instead, they have various levers that predictably cause rational actors to voluntarily change their own rates. Maybe this has always been obvious to you, but it wasn't to me at some point. If you still feel this is "blatantly incorrect information," I'm certainly open to learning more.
        nickles 5y ago
        I apologize for my brusque response, it wasn’t constructive. > the Fed has no mechanism to enforce the rate banks offer to each other or to consumers -- as in, there's no legal enforcement anywhere The Fed can affect rates directly by transacting directly with the market (open market operations). Ultimately, all bond prices (and correspondingly yields) are driven by supply and demand. The Fed has unlimited capacity to purchase bonds (driving yields down) and currently has about $9T of bonds that it can sell (pushing rates up). The Fed doesn’t need to force any market participant to change yields, it can do it mechanically. The Bank of Japan explicitly does this. The Fed also has regulatory authority over US banks, which conceivably can impact rates (think RRR and stress tests). It (along with other regulators like FDIC) can even specify the composition of bank portfolios (which determines where flows go). > Instead, they have various levers that predictably cause rational actors to voluntarily change their own rates Certainly rational actors respond to Fed actions of their own volition, but don’t underestimate the mechanical aspects of markets (e.g. dealers need to hedge risk and changes in rates change duration, risk parity funds and CTAs have mandates to follow, etc.)
- nickles 5y ago
  > the Fed doesn't actually set interest rates It's not clear cut as to what degree interest rates are exogenous inputs that central banks respond to, but the Fed absolutely does set interest rates, allowing some variability between upper and lower bounds. Today, Fed adjusted interest on reserve balances (IORB, formerly IOER/IORR) to 40bps from 15bps. This rate determines how much interest banks are paid for reserves kept at the Fed. In theory, this rate acts as a floor for the effective fed funds rate. In practice, it's somewhat murkier. The Fed also sets the discount rate (now 50bps), which is meant to act as a ceiling on rates. Banks are able to borrow money from the Fed's discount window if they need it; however, there's a stigma associated with utilizing this facility. The Fed now maintains standing repo and reverse repo facilities to help banks manage liquidity. These policies all target the front end of the yield curve, which is where Fed has the most control. To manipulate the long end of the curve, Fed implemented QE. Other central banks (e.g. BoJ) have gone further, using yield curve control to explicitly impact the term structure. > Instead they purchase and sell treasuries to member banks, such that those banks' balance sheets change in such a way as to make money more or less expensive to trade amongst themselves, which has knock-on effects for consumers. Repo rates are determined by the market, but are bounded by the rates at Fed's repo facilities. A catch here is that not all market participants have direct access to these. While repo rates may impact behavior, the Fed's intended mechanism is IORB, which (ignoring steepness of the yield curve) influences how attractive banks find loaning money to clients. > the mechanism that causes banks to have to borrow from each other (to meet the nightly reserve requirement, historically) This market used to be the Fed Funds market, which consisted of uncollateralized loans between banks. The fed funds market is basically dead, replaced by the repo market, which is collateralized. IIRC, the remaining participants are GSEs like Fannie Mae and Freddie Mac, which can't collect IORB. They sweep their cash to banks and split the interest (which is why IORB can act as a ceiling instead of a floor).
- sbelskie 5y ago
  “ Adjustments to the IORB rate help to move the federal funds rate into the target range set by the FOMC. Banks should be unwilling to lend to any private counterparty at a rate lower than the rate they can earn on balances maintained at the Federal Reserve. As a result, an increase in the IORB rate will put upward pressure on a range of short-term interest rates. The opposite holds for a decrease in the IORB rate. Typically, changes in the FOMC's target range are accompanied by commensurate changes in the IORB rate, thus providing incentives for the federal funds rate to adjust to a level consistent with the FOMC's target.” https://www.federalreserve.gov/faqs/why-is-the-federal-reserve-paying-banks-interest.htm https://www.federalreserve.gov/faqs/why-is-the-federal-reser...
bogomipz 5y ago
The FOMC(Federal Open Market Committee) is the policy arm of the Fed. They can not and do not set interest rates directly. What they do is adjust the money supply to try to influence interest rates towards a target range. One of the tools they have to do this is the the federal funds rate which is the rate that banks charge each other to borrow money overnight in order to meet their reserve requirements. The Fed Funds rate is one of the tools they have their disposal. The FOMC meets 8 times and year releases this guidance.
- monktastic1 5y ago
  As I mentioned in a sibling comment, there hasn't been a reserve requirement for two years. I'm not sure what's primarily driving the interbank borrowing now.
  - sbelskie 5y ago
    But doesn’t the Fed still pay on reserves held? Even if it’s not required, the Fed increasing the rate paid on reserves would put upward pressure on other rates, otherwise banks would just take the IORB rate.
  - bogomipz 5y ago
    The Fed Funds rate is still the reference for policy but the Fed has been using a new framework called "ample reserves" since the latter part of 2020. See: "How Does the Fed Influence Interest Rates Using Its New Tools?" https://www.stlouisfed.org/open-vault/2020/august/how-does-fed-influence-interest-rates-using-new-tools https://www.stlouisfed.org/open-vault/2020/august/how-does-f...
    - nickles 5y ago
      > the Fed has been using a new framework called "ample reserves" since the latter part of 2020 It’s been using an ample reserve regime for much longer than that. The Fed received congressional approval to implement a floor system around 2007 (it had been seeking it since the 80’s, I think), and has used it since the GFC. Are you possibly referring to the average inflation targeting framework?

First I have heard of this and quite interesting to learn. Could you explain the difference ? Does this mean they are going to implement the rate increase some point in future ala target ?

blawson 5y ago

Not GP, but I don't think there's an actual "rate" as such - it's the actions the Fed takes to balance prices such that it falls within their target: https://www.newyorkfed.org/markets/reference-rates/effr https://www.newyorkfed.org/markets/reference-rates/effr

monktastic1 5y ago

As another reply indicated, the Fed doesn't actually set interest rates. That's a common misconception. Instead they purchase and sell treasuries to member banks, such that those banks' balance sheets change in such a way as to make money more or less expensive to trade amongst themselves, which has knock-on effects for consumers. On the other hand, since there's no longer a reserve requirement since the start of covid, the mechanism that causes banks to have to borrow from each other (to meet the nightly reserve requirement, historically) is much less clear to me. Hopefully an economist can chime in.

drexlspivey 5y ago
> As another reply indicated, the Fed doesn't actually set interest rates. That's a common misconception. The FED absolutely sets the interest rates by controlling the federal reserve rate which is the interaste rate paid to banks every day for their deposits with the FED
- monktastic1 5y ago
  The Fed (not FED, BTW) doesn't "set" the rates, but has policies (including IORB, or what you call the federal reserve rate) which guide the markets to arrive at their target. Maybe that's a small distinction, but I think it helps OP, because I labored under the same confusion for a while.
  - nickles 5y ago
    > The Fed (not FED, BTW) doesn't "set" the rates, but has policies (including IORB, or what you call the federal reserve rate) The Fed does explicitly set certain interest rates. IORB is an interest rate that gets paid out every single day to market participants. “Federal reserve rate” does not exist; what you’re probably referring to is the fed funds rate. The Fed sets a target range for this, and, if the effective fed funds rate does not stay within the target corridor, the Fed will conduct open market operations to push it there.
    - monktastic1 5y ago
      "Federal reserve rate" is not my term. My parent comment coined it and defined it as "the interaste (sic) rate paid to banks every day for their deposits with the FED", which is the IORB. I appreciate the thorough and accurate response you gave (and which I learned from). The distinction I've been trying to make is that the Fed has no mechanism to enforce the rate banks offer to each other or to consumers -- as in, there's no legal enforcement anywhere. Instead, they have various levers that predictably cause rational actors to voluntarily change their own rates. Maybe this has always been obvious to you, but it wasn't to me at some point. If you still feel this is "blatantly incorrect information," I'm certainly open to learning more.
      - nickles 5y ago
        I apologize for my brusque response, it wasn’t constructive. > the Fed has no mechanism to enforce the rate banks offer to each other or to consumers -- as in, there's no legal enforcement anywhere The Fed can affect rates directly by transacting directly with the market (open market operations). Ultimately, all bond prices (and correspondingly yields) are driven by supply and demand. The Fed has unlimited capacity to purchase bonds (driving yields down) and currently has about $9T of bonds that it can sell (pushing rates up). The Fed doesn’t need to force any market participant to change yields, it can do it mechanically. The Bank of Japan explicitly does this. The Fed also has regulatory authority over US banks, which conceivably can impact rates (think RRR and stress tests). It (along with other regulators like FDIC) can even specify the composition of bank portfolios (which determines where flows go). > Instead, they have various levers that predictably cause rational actors to voluntarily change their own rates Certainly rational actors respond to Fed actions of their own volition, but don’t underestimate the mechanical aspects of markets (e.g. dealers need to hedge risk and changes in rates change duration, risk parity funds and CTAs have mandates to follow, etc.)
nickles 5y ago
> the Fed doesn't actually set interest rates It's not clear cut as to what degree interest rates are exogenous inputs that central banks respond to, but the Fed absolutely does set interest rates, allowing some variability between upper and lower bounds. Today, Fed adjusted interest on reserve balances (IORB, formerly IOER/IORR) to 40bps from 15bps. This rate determines how much interest banks are paid for reserves kept at the Fed. In theory, this rate acts as a floor for the effective fed funds rate. In practice, it's somewhat murkier. The Fed also sets the discount rate (now 50bps), which is meant to act as a ceiling on rates. Banks are able to borrow money from the Fed's discount window if they need it; however, there's a stigma associated with utilizing this facility. The Fed now maintains standing repo and reverse repo facilities to help banks manage liquidity. These policies all target the front end of the yield curve, which is where Fed has the most control. To manipulate the long end of the curve, Fed implemented QE. Other central banks (e.g. BoJ) have gone further, using yield curve control to explicitly impact the term structure. > Instead they purchase and sell treasuries to member banks, such that those banks' balance sheets change in such a way as to make money more or less expensive to trade amongst themselves, which has knock-on effects for consumers. Repo rates are determined by the market, but are bounded by the rates at Fed's repo facilities. A catch here is that not all market participants have direct access to these. While repo rates may impact behavior, the Fed's intended mechanism is IORB, which (ignoring steepness of the yield curve) influences how attractive banks find loaning money to clients. > the mechanism that causes banks to have to borrow from each other (to meet the nightly reserve requirement, historically) This market used to be the Fed Funds market, which consisted of uncollateralized loans between banks. The fed funds market is basically dead, replaced by the repo market, which is collateralized. IIRC, the remaining participants are GSEs like Fannie Mae and Freddie Mac, which can't collect IORB. They sweep their cash to banks and split the interest (which is why IORB can act as a ceiling instead of a floor).
sbelskie 5y ago
“ Adjustments to the IORB rate help to move the federal funds rate into the target range set by the FOMC. Banks should be unwilling to lend to any private counterparty at a rate lower than the rate they can earn on balances maintained at the Federal Reserve. As a result, an increase in the IORB rate will put upward pressure on a range of short-term interest rates. The opposite holds for a decrease in the IORB rate. Typically, changes in the FOMC's target range are accompanied by commensurate changes in the IORB rate, thus providing incentives for the federal funds rate to adjust to a level consistent with the FOMC's target.” https://www.federalreserve.gov/faqs/why-is-the-federal-reserve-paying-banks-interest.htm https://www.federalreserve.gov/faqs/why-is-the-federal-reser...

bogomipz 5y ago

The FOMC(Federal Open Market Committee) is the policy arm of the Fed. They can not and do not set interest rates directly. What they do is adjust the money supply to try to influence interest rates towards a target range. One of the tools they have to do this is the the federal funds rate which is the rate that banks charge each other to borrow money overnight in order to meet their reserve requirements. The Fed Funds rate is one of the tools they have their disposal. The FOMC meets 8 times and year releases this guidance.

monktastic1 5y ago
As I mentioned in a sibling comment, there hasn't been a reserve requirement for two years. I'm not sure what's primarily driving the interbank borrowing now.
- sbelskie 5y ago
  But doesn’t the Fed still pay on reserves held? Even if it’s not required, the Fed increasing the rate paid on reserves would put upward pressure on other rates, otherwise banks would just take the IORB rate.
- bogomipz 5y ago
  The Fed Funds rate is still the reference for policy but the Fed has been using a new framework called "ample reserves" since the latter part of 2020. See: "How Does the Fed Influence Interest Rates Using Its New Tools?" https://www.stlouisfed.org/open-vault/2020/august/how-does-fed-influence-interest-rates-using-new-tools https://www.stlouisfed.org/open-vault/2020/august/how-does-f...
  - nickles 5y ago
    > the Fed has been using a new framework called "ample reserves" since the latter part of 2020 It’s been using an ample reserve regime for much longer than that. The Fed received congressional approval to implement a floor system around 2007 (it had been seeking it since the 80’s, I think), and has used it since the GFC. Are you possibly referring to the average inflation targeting framework?