10.4 Tools of Monetary Policy

Notes

Monetary policy is the Fed's actions to change the money supply and interest rates.

• Open market operations: the Fed buys or sells government securities. Buying securities adds reserves to banks and pushes interest rates down. Selling securities removes reserves and pushes rates up.
• Federal funds rate: the interest rate banks charge each other for overnight loans of reserves. The FOMC sets a target range for it, and other rates, such as the prime rate banks charge their best customers, tend to move with it.
• Discount rate: the interest rate the Fed charges banks that borrow directly from it. Raising it discourages bank borrowing.
• Interest on reserve balances: the rate the Fed pays banks on reserves they hold at the Fed. Raising it encourages banks to hold reserves rather than lend at lower rates, which pushes market rates up. This is now one of the Fed's main tools.
• Reserve requirements: raising the required ratio reduces how much banks can lend. The Fed rarely changes it and set it to zero in 2020.
• In crises, the Fed has also bought large amounts of long-term securities, called quantitative easing, to lower long-term interest rates.