Editing Federal Reserve (section)

=== Monetary Operations ===
The Federal reserve handles money supply through four main levers, all aimed at increasing or decreasing the '''federal funds rate''', which is the rate at which banks make overnight loans to each other. This is what is referred to when it is said that the fed is 'changing interest rates.' These operations aim either to effect supply or demand.<ref>Mishkin, Frederic S., and Apostolos Serletis. ''The Economics of Money, Banking and Financial Markets''. 4th Canadian ed. Toronto: Pearson Addison Wesley, 2011. 

(I rely in this section mainly on this work, but intermixed with notes I took in an undergraduate course on Banking; diagrams are from this textbook) </ref>

==== Open Market Operations (Supply) ====
[[File:OPEN MARKET OPERATIONS.png|thumb|348x348px]]
First, and used more commonly than any other method since the 1980s, are '''Open Market Operations''' conducted by the New York Fed under the oversight of the Federal Open Market Committee. Primary dealers keep in contact through a dedicated desk at the NY Fed, and buy Governmental bonds from the fed using TRAPS (Trading Room Automated Processing System), a software used exclusively for these transactions. There are two types, defensive and dynamic. Defensive operations try to stabilize the market in response to some externality. For this reason, they are usually temporary measures like repo or matched sale-purchase agreements. Repo is when the fed buys securities with an understanding that they will be returned at a future data, and matched sale-purchase agreements are just the opposite, the Fed selling with an agreement for future re-acquisition. Dynamic operations, like that of Jerome Powel in March of 2023 to raise interest rates, are when the fed wants to make a change in the market, in this instance to fight inflation.

For an example of how this '''money creation''' might work, imagine a transaction between the Fed and Wells Fargo. Say the economy is slowing down and the Fed wants to gas it up, they might purchase 100 government securities from Wells Fargo. Wells Fargo will have less government securities (issued at the discretion of the Treasury), and Fed will have more. '''Under the federal reserve system, minimum reserves are set, and Banks are required to keep these required reserves (RR) in an account at the Fed. So in return for the government issued securities, the Fed credits the account the Bank has with them. Just writes something on a line. This increases the Banks reserves, increasing the amount they can lend.''' In economese this increases the Monetary Base (and, necessarily, the Money Supply) by 100. If the bank chooses to keep it in currency rather than deposits, then reserves stay the same but the effect on the monetary base is the same. In the case of sales it is just the opposite and the money supply decreases.

In the chart, purchases increase the amount of non-borrowed reserves, shifting the vertical portion of the supply curve right and thereby lowering the federal funds rate, leading to an increase in overall market liquidity. In the second, because the federal funds rate cannot fall below the interest rate paid on reserves, we hit the flat section and there is no effect on federal funds rate

==== Discount Rate (Supply) ====
[[File:DISCOUNT RATE.png|thumb|366x366px|Discount Rate Diagram]]
A second supply targeting method is to charge the discount rate. Banks can borrow from each other or from the Fed. If they borrow from each other they they face the federal funds rate. If they borrow from the Fed they face the '''discount rate.''' Since 2003, Reserve Banks establish the primary credit rate at least every 14 days, subject to review and determination of the Board of Governors.

Federal Reserve Banks have three main lending programs for depository institutions — primary credit, secondary credit and seasonal credit. Primary credit is offered on a very short-term basis as a backup rather than a regular source of funding, and borrowers are not required to seek alternative sources of funds before requesting. Secondary credit is also short term and is offered to banks not eligible for primary credit. It is meant to get people back to normal market funding. Seasonal credit is available to relatively small depository institutions to meet regular seasonal funding needs.

As we can see, the discount rate is represented by the horizontal portion of the supply curve, and changes here will only have an effect if the market is in a state where the discount window rate is desirable. If this is the case, then lowering the discount rate lowers the federal funds rate and vice versa.

==== Requirement Ratio (Demand) ====
[[File:REQUIREMENT RATIO.png|thumb|301x301px|Requirement Ratio Diagram]]
Open Market Operations and the Discount Rate effect supply, but the Federal Reserve has two more methods, each effecting demand. First, they can change the '''requirement ratio''', which is the amount of reserves banks are required to keep in the with the fed. Because these reserves cannot be used for investment, ''increasing the required reserves '''increases demand,''' shifts demand for funds right, lowering the federal funds rate'' (increasing liquidity), or vice-versa.

==== Interest on Reserves (Demand) ====
[[File:INTEREST ON RESERVES1.png|thumb|330x330px|Interest on Reserves Diagram]]
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. First authorized by Congress 2006 with implementation scheduled for 2011, the program was fast tracked in response to the crisis. This was pursuant of Fed policy: buying up toxic assets while minimizing the effect this would traditionally have had on general liquidity. Fed officials feared the federal funds rate would dip below their target and cause price instability. <blockquote>To avoid this outcome, the Fed "sterilized" the effect of liquidity injections on the overall economy: It sold an equal amount in Treasury securities from its own account to banks. Sterilization offset the injections' effect on the monetary base and therefore the overall supply of credit, keeping the total supply of reserves largely unchanged and the fed funds rate at its target. Sterilization reduced the amount in Treasury securities that the Fed held on its balance sheet by roughly 40 percent in a year's time, from over $790 billion in July 2007 to just under $480 billion by June 2008. However, following the failure of Lehman Brothers and the rescue of American International Group in September 2008, credit market dislocations intensified and lending through the Fed's new lending facilities ballooned. The Fed no longer held enough Treasury securities to sterilize the lending.


This led the Fed to request authority to accelerate implementation of the IOR policy that had been approved in 2006. Once banks began earning interest on the excess reserves they held, they would be more willing to hold on to excess reserves instead of attempting to purge them from their balance sheets via loans made in the fed funds market, which would drive the fed funds rate below the Fed's target for that rate. When the Fed stopped sterilizing its liquidity injections, the monetary base (which is comprised of total reserves in the banking system plus currency in circulation) ballooned in line with Fed lending, from about $847 billion in August 2008 to almost $2 trillion by October 2009. However, this did not result in a proportional increase in the overall money supply (Figure 1). This result is likely due largely to an undesirable lending environment: Banks likely found it more desirable to hold excess reserves in their accounts at the Fed, earning the IOR rate with zero risk, given that there were few attractive lending opportunities. That the liquidity injections did not result in a proportional increase in the money supply may also be due to banks' increased demand to hold liquid reserves (as opposed to individually lending those excess reserves out) in the wake of the financial crisis<ref>The Effect of Interest on Reserves on Monetary Policy, Federal Reserve Bank of Richmond, 2009[https://web.archive.org/web/20231004123632/https://www.richmondfed.org/publications/research/economic_brief/2009/eb_09-12#:~:text=On%20October%2013%2C%202006%2C%20the,%2C%20to%20October%201%2C%202008. https://web.archive.org/web/20231004123632/https://www.richmondfed.org/publications/research/economic_brief/2009/eb_09-12#:~:text=On%20October%2013%2C%202006%2C%20the,%2C%20to%20October%201%2C%202008.]</ref></blockquote>In the graph, IOR 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.

==== Extraordinary Measures (2008) ====
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 (usually) 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'''.
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