Federal funds rate
The interest rate on overnight loans of reserves from one bank to another
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| Term | Definition |
|---|---|
| Federal funds rate | The interest rate on overnight loans of reserves from one bank to another |
| Primary instrument of monetary policy | Federal funds rate is the primary tool of monetary policy |
| Market for reserves | The market where the federal funds rate is determined |
| Equilibrium in the market for reserves | The point where quantity of reserves demanded equals quantity of reserves supplied |
| Quantity of reserves demanded | Required reserves plus quantity of excess reserves demanded |
| Excess reserves | Insurance against deposit outflows; opportunity cost is interest forgone on lending minus interest earned on reserves |
| Federal funds rate vs ioer | If federal funds rate > ioer |
| Demand curve Rd | Downward sloping when federal funds rate is above ioer; flat at ioer if rate falls below it |
| Non-borrowed reserves (NBR) | Reserves supplied by the Fed through open market operations |
| Borrowed reserves (BR) | Reserves borrowed from the Fed |
| Discount rate id | Interest rate charged by the Fed on discount loans; set above federal funds target |
| Federal funds rate iff | Interest rate on federal funds; if below discount rate id |
| Vertical section of supply curve | NBR supplied equals total supply; BR = 0 |
| Flat section of supply curve | Supply curve becomes infinitely elastic at discount rate id |
| Market equilibrium | Rs = Rd with equilibrium federal funds rate i*ff |
| Open market purchase | Fed buys securities → increases reserves → shifts NBR supply curve right → federal funds rate falls |
| Open market sale | Fed sells securities → reduces reserves → federal funds rate rises |
| Discount lending effect | Depends on whether demand intersects vertical or flat section of supply curve; lower discount rate may lower federal funds rate if BR > 0 |
| Reserve requirements increase | Required reserves rise → demand curve shifts right → federal funds rate rises |
| Reserve requirements decrease | Required reserves fall → demand curve shifts left → federal funds rate falls |
| Interest on excess reserves | Sets floor for federal funds rate; increasing ioer can raise federal funds rate if it is at flat section |
| Dynamic open market operations | Intended to change level of reserves and monetary base |
| Defensive open market operations | Offset movements in reserves due to other factors |
| Repo transaction | Fed purchases securities with agreement to sell back in short time; defensive OMO |
| Matched sale-purchase (reserve repo) | Temporary open market sale with agreement to repurchase |
| Discount window | Facility for banks to borrow reserves from the Fed |
| Primary credit | Discount lending for healthy banks |
| Secondary credit | Discount lending for troubled banks at higher penalty rate |
| Seasonal credit | Discount lending for small banks with seasonal deposit needs |
| Lender of last resort | Fed provides reserves to banks when no one else will to prevent panics |
| Required reserve ratio effect on money supply | Rise reduces deposits supported → contracts money supply; fall expands money supply |
| Effective-lower-bound problem | Central bank cannot lower policy rate much below zero |
| Nonconventional monetary policy tools | Liquidity provision |
| Liquidity provision | Fed increases lending facilities to provide liquidity to financial markets |
| Large-scale asset purchases (LSAPs) | Fed buys securities to lower interest rates and stimulate credit markets |
| Credit easing | Changing composition of Fed balance sheet to improve credit market functioning |
| Forward guidance | Commitment to keep rates low to shape expectations of future interest rates |
| Negative interest rates on bank deposits | Banks pay central bank to hold deposits to stimulate lending |
| ECB target financing rate | Sets target for overnight cash rate |
| Overnight cash rate | Interest rate for very short-term interbank loans |
| ECB main refinancing operations | Weekly reverse transactions |
| Longer-term refinancing operations | Monthly operations |
| ECB lending to banks | Conducted via marginal lending facility against eligible collateral |
| Deposit facility | Standing facility paying interest on excess reserves |
| ECB reserve requirements | Banks must hold 2% of short-term deposits in reserve accounts |