Floor System Federal Reserve

The federal reserve s floor system can be a drag on economic growth because if set above market rates it will discourage lending and investment and stifle economic activity.

Floor system federal reserve.

Instead it is a market rate of interest that one bank charges to another bank on very short term loans of reserves that is funds held on deposit at the fed. Fed s pre 2008 corridor system. The federal reserve system is an independent government institution that has private aspects. To protect against the floor system s future costs the federal reserve should however restrict its balance sheet policy to bagehot s principles for last resort lending.

However many may not know exactly how the fed does that. An article in the regional economist discusses the various interest rates the fed sets. In this system the demand curve of the bank reserve market is downward sloping with respect to the interbank interest rate. A floor system entails the federal reserve purposefully supplying the banking system with more than enough reserves to push the effective federal funds rate down to the interest rate on reserves.

Today s post is the first of a two part series on how the federal reserve influences interest rates. The system is not a private organization and does not operate for the purpose of making a profit. Mcfadden chairman of the house banking currency committee speech on the floor of the house of representatives june 10 1932. To maintain the floor system s present benefits the federal reserve should therefore continue to implement interest rate policy through interest on reserves.

Before 2008 the interest rate policy system is a so called corridor system where the discount rate served as the corridor ceiling and the zero lower bound zlb was the floor. To understand how this new floor system works one must start by recalling that despite its name the federal funds rate is not controlled directly by the federal reserve. In contrast in a floor system reserves are abundant so that the interest rate the federal reserve pays on excess reserves or ioer is the primary tool used to control the federal funds rate. Many people know that the federal reserve affects interest rates.

To avoid repeating its 2008 mistake the fed does not necessarily need to abandon its use of ioer but it. We show that this is not the case. The system derives its authority and public purpose from the federal. A floor system therefore allows the federal reserve to target a positive price and quantity of reserves simultaneously while holding reserve.

In a floor system of monetary policy implementation the central bank remunerates bank reserves at or near the market rate of interest. The stocks of the regional federal reserve banks are owned by the banks operating within that region and which are part of the system.