First I have heard of this and quite interesting to learn. Could you explain the difference ? Does this mean they are going to implement the rate increase some point in future ala target ?
On the other hand, since there's no longer a reserve requirement since the start of covid, the mechanism that causes banks to have to borrow from each other (to meet the nightly reserve requirement, historically) is much less clear to me. Hopefully an economist can chime in.
The FED absolutely sets the interest rates by controlling the federal reserve rate which is the interaste rate paid to banks every day for their deposits with the FED
The Fed does explicitly set certain interest rates. IORB is an interest rate that gets paid out every single day to market participants. “Federal reserve rate” does not exist; what you’re probably referring to is the fed funds rate. The Fed sets a target range for this, and, if the effective fed funds rate does not stay within the target corridor, the Fed will conduct open market operations to push it there.
I appreciate the thorough and accurate response you gave (and which I learned from). The distinction I've been trying to make is that the Fed has no mechanism to enforce the rate banks offer to each other or to consumers -- as in, there's no legal enforcement anywhere. Instead, they have various levers that predictably cause rational actors to voluntarily change their own rates. Maybe this has always been obvious to you, but it wasn't to me at some point.
If you still feel this is "blatantly incorrect information," I'm certainly open to learning more.
> the Fed has no mechanism to enforce the rate banks offer to each other or to consumers -- as in, there's no legal enforcement anywhere
The Fed can affect rates directly by transacting directly with the market (open market operations). Ultimately, all bond prices (and correspondingly yields) are driven by supply and demand. The Fed has unlimited capacity to purchase bonds (driving yields down) and currently has about $9T of bonds that it can sell (pushing rates up). The Fed doesn’t need to force any market participant to change yields, it can do it mechanically. The Bank of Japan explicitly does this.
The Fed also has regulatory authority over US banks, which conceivably can impact rates (think RRR and stress tests). It (along with other regulators like FDIC) can even specify the composition of bank portfolios (which determines where flows go).
> Instead, they have various levers that predictably cause rational actors to voluntarily change their own rates
Certainly rational actors respond to Fed actions of their own volition, but don’t underestimate the mechanical aspects of markets (e.g. dealers need to hedge risk and changes in rates change duration, risk parity funds and CTAs have mandates to follow, etc.)
GP is correct in that the fed funds rate (the one that makes headlines and is used for policy) isn't literally _set_ by fiat: the Fed just intervenes in the interbank money market to ensure it stays in a specified range. It has near unlimited capacity to intervene so the fed funds rate only ever strays a tiny amount outside that range, and even then it's an exceptional circumstance.
On the other hand the parent is correct in that the Fed literally sets a lot of other rates that are used for financial plumbing.
Nickles I'm sure you know this already but I'm trying to clarify so that others don't get confused by an already confusing topic.
I always recommend the book Floored! by George Selgin for those who want to understand current Fed policy. It’s a few years old at this point but does a fantastic job explaining things.
It's not clear cut as to what degree interest rates are exogenous inputs that central banks respond to, but the Fed absolutely does set interest rates, allowing some variability between upper and lower bounds.
Today, Fed adjusted interest on reserve balances (IORB, formerly IOER/IORR) to 40bps from 15bps. This rate determines how much interest banks are paid for reserves kept at the Fed. In theory, this rate acts as a floor for the effective fed funds rate. In practice, it's somewhat murkier.
The Fed also sets the discount rate (now 50bps), which is meant to act as a ceiling on rates. Banks are able to borrow money from the Fed's discount window if they need it; however, there's a stigma associated with utilizing this facility. The Fed now maintains standing repo and reverse repo facilities to help banks manage liquidity.
These policies all target the front end of the yield curve, which is where Fed has the most control. To manipulate the long end of the curve, Fed implemented QE. Other central banks (e.g. BoJ) have gone further, using yield curve control to explicitly impact the term structure.
> Instead they purchase and sell treasuries to member banks, such that those banks' balance sheets change in such a way as to make money more or less expensive to trade amongst themselves, which has knock-on effects for consumers.
Repo rates are determined by the market, but are bounded by the rates at Fed's repo facilities. A catch here is that not all market participants have direct access to these. While repo rates may impact behavior, the Fed's intended mechanism is IORB, which (ignoring steepness of the yield curve) influences how attractive banks find loaning money to clients.
> the mechanism that causes banks to have to borrow from each other (to meet the nightly reserve requirement, historically)
This market used to be the Fed Funds market, which consisted of uncollateralized loans between banks. The fed funds market is basically dead, replaced by the repo market, which is collateralized. IIRC, the remaining participants are GSEs like Fannie Mae and Freddie Mac, which can't collect IORB. They sweep their cash to banks and split the interest (which is why IORB can act as a ceiling instead of a floor).
https://www.federalreserve.gov/faqs/why-is-the-federal-reser...
"How Does the Fed Influence Interest Rates Using Its New Tools?"
https://www.stlouisfed.org/open-vault/2020/august/how-does-f...
It’s been using an ample reserve regime for much longer than that. The Fed received congressional approval to implement a floor system around 2007 (it had been seeking it since the 80’s, I think), and has used it since the GFC. Are you possibly referring to the average inflation targeting framework?