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Fixing the “Textbook Lag” with FRED (Part II)

Monetary policy in a world of ample reserves

Your economics textbook may still say the Federal Reserve uses open market operations to influence the federal funds rate. But in today’s economy, the Fed uses different policy tools.

In simple terms, this is how monetary policy currently works: The FOMC sets a target range for the federal funds rate (FFR) and uses interest on excess reserves (IOER) and the overnight reverse repurchase agreement (ON RRP) facility to keep the FFR rate in the target range. (See our previous post for an introduction to this topic.)

The Fed pays IOER to banks holding reserves at the Fed, which offers those banks a safe, risk-free investment option. Arbitrage ensures that the FFR doesn’t drift too far from the IOER rate. If the FFR drifts much below the IOER rate, banks then have an incentive to borrow in the federal funds market at the lower FFR and deposit those reserves at the Fed to earn the higher IOER rate.

From December 16, 2008, to June 13, 2018, the IOER and ON RRP rates, respectively, served as the upper and lower limits of the FFR target range. The FFR moved between the two rates, but over time it has moved closer to the IOER—that is, the gap between the two has closed, as shown in the FRED graph above.

Again, because the IOER rate was set at the upper limit of the target range, as the FFR moved closer to the IOER rate, by definition it moved closer to the upper limit of the range. To ensure that the FFR remained within the range, the Fed has lowered the IOER rate by 5 basis points at three different times in the past year: June 13, 2018; December 19, 2018; and May 1, 2019. The IOER is now set 15 basis points below the upper limit of the target range.

These changes weren’t changes in monetary policy (which affects the choice of target range), but rather were slight adjustments to where the FFR sits within the range. Chairman Jerome Powell explained that the adjustments were intended to “move the federal funds rate closer to the middle of the target range” in his press conference on June 13, 2018. The changes can be seen on the FRED graph below: Prior to the June 13, 2018, adjustment, the upper limit of the FFR target range and the IOER rate were indistinguishable because IOER rate was set at the upper limit of the target range. After June 13, 2018, the IOER rate (green line) is below the upper limit of the FFR target range (red line).

These changes have ensured that the FFR has remained between the upper and lower limits of the range throughout the period, as illustrated by the FRED graph below.

How these graphs were created: For the first graph: Search for “interest rate on excess reserves,” select “Effective Federal Funds Rate (daily)” and “Interest Rate on Excess Reserves,” and then click “Add to Graph.” Adjust the dates to reflect the indicated range: from December 16, 2008, to the current date. For the second graph: Search for “federal funds rate target” and select “Federal Funds Target Range – Upper Limit,” “Federal Funds Rate – Lower Limit,” and “Effective Federal Funds Rate (daily),” and then click “Add to Graph.” From the “Edit Graph” panel, use the “Add Line” option to search for “Interest Rate on Excess Reserves” and then select “Add data series.” Adjust the dates to reflect the indicated range: from January 1, 2018, to the current date. For the third graph: Search for “federal funds rate target” and select “Federal Funds Target Range – Upper Limit,” “Federal Funds Rate – Lower Limit,” and “Effective Federal Funds Rate (daily),” and then click “Add to Graph.” Adjust to date to show the entire period: from December 16, 2008, to the current date. In each case, you can adjust the colors to your liking by using the color palette in the “Edit Graph” panel’s “Format” tab.

For more information on this topic, see “A New Frontier: Monetary Policy with Ample Reserves.”

Suggested by Scott Wolla.

View on FRED, series used in this post: DFEDTARL, DFEDTARU, DFF, IOER

Fixing the “Textbook Lag” with FRED (Part I)

Monetary policy in a world of ample reserves

Your economics textbook may still say the Federal Reserve uses open market operations to influence the federal funds rate. But in today’s economy, the Fed uses different policy tools.

Before September 2008, when reserves were scarce, the Federal Reserve bought and sold relatively small quantities of Treasury securities to adjust the level of bank reserves and influence the federal funds rate (FFR). But we now live in an environment of ample reserves. As such, the Federal Reserve can no longer effectively influence the FFR by making small changes in the supply of those reserves. Instead, the Fed uses its newer tools—paying interest on excess reserves (IOER) and the overnight reverse repurchase agreement (ON RRP) facility—to influence the FFR.

Since December 16, 2008, the FOMC has set a target range for the FFR, rather than a specific single target, and uses the rates on IOER and the ON RRP facility to keep the FFR rate in that target range. This process has ensured that the FFR has remained between the upper limit and the lower limit of the range.

The graph above tracks the actual FFR and the upper and lower limits of the range. Our next FRED Blog post provides more details. Stay tuned…

For more information on this topic, see “A New Frontier: Monetary Policy with Ample Reserves.”

How this graph was created: Search for “federal funds rate target”; select “Federal Funds Target Range – Upper Limit,” “Federal Funds Rate – Lower Limit,” and “Effective Federal Funds Rate (daily)”; and click “Add to Graph.” Adjust the date to show the entire period: December 16, 2008, to the current date. In each case, you can adjust the colors to your liking by using the color palette in the “Edit Graph” panel’s “Format” tab.

Suggested by Scott Wolla.

View on FRED, series used in this post: DFEDTARL, DFEDTARU, DFF

Federal funds rate: target vs. reality

The traditional policy tool of the Fed is to target the federal funds rate. Note the term target. Indeed, the Fed does not set this interest rate; rather, it sets the target and then conducts open market operations so that the overnight interest rate on funds deposited by banks at the Fed reaches that target. Obviously, reaching the target is sometimes harder to do, especially in times when there’s a lot of uncertainty in the markets. The graph above compares the target (or target band more recently) with the effective federal funds rate. While the two coincide quite well over most of the 10-year period, there are important deviations that correspond to various financial market events. Nevertheless, these deviations are short-lived, which shows that the open market operations do have the desired effect.

How this graph was created: Search for “federal funds rate” and these four series should be among the top choices. Select the daily rates and use the “Add to graph” button to add them to the graph.

Suggested by Christian Zimmermann

View on FRED, series used in this post: DFEDTAR, DFEDTARL, DFEDTARU, DFF


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