Federal Reserve: Difference between revisions

Another way to affect demand is by changing interest on reserves. Until 2008, the Federal Reserve did not pay interest on reserves banks held with them, when it was introduced as an additional form of leverage. Paying interest on reserves allows the Fed to place a floor on the federal funds rate (the horizontal line in the supply curve), because banks have little reason to lend at rates below the rate of interest they receive on their reserve balances. The rate is determined by the Board of Governors.

Above are the conventional methods of monetary policy. In some circumstances, they become insufficient. In particular, there is what is known as the '''Zero-Lower Bound Problem'''. Interest rates, for obvious reasons, cannot be negative, so as they approach zero there comes a point where nothing further can be done. If the economy is still unresponsive, the Fed can, as it did in 2008, take extraordinary measures. One method was to '''extend the term of discount loans''', giving banks longer to pay them back. Another was the '''Term Auction Facility''', through which the Fed extended 3.8 trillion in collateralized loans at rates below the discount rate. The auctions were administered by the New York Fed though loans were offered through all twelve of the Federal Reserve Banks. At the same time, the Fed also began to make '''large scale purchases of toxic assets'''.