Federal Short Term Rate 2013 – Once upon a time, US monetary policy was defined with its primary objective in terms of the Fed Funds rate, which is the interest rate on an overnight loan of Federal Reserve deposits between private banks or other institutions that have accounts with the Fed. A bank that ended the day with more deposits in its account with the Fed than was needed to meet its required balances could lend those funds to another bank that found itself short. The interest rate on these loans was very sensitive to the overall level of excess reserves in the system. The Fed’s direct control over available reserves gave it close control over the interest rate on fed funds loans, making Fed funds a credible target for the implementation of FOMC policy directives.
But that was at the time when only about $10 billion in Federal Reserve deposits were required to meet all the needs of the banking system. Today, the Fed has created $2.5 trillion in deposits, and the number is still growing.
Federal Short Term Rate 2013
Nevertheless, overnight loans from mutual funds continue to be made and the interest on these loans continues to be reported. Last week, for example, the Fed Fund rate averaged 0.08% (8 basis points). If you borrowed $1,000 every day at that rate, you would have earned about 80 cents in interest by the end of the year.
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There are a few things that are surprising about a fed funds rate of only 0.08%. First, why on earth would an institution lend money to another bank for 8 basis points when it could just hold those reserves overnight in its account with the Fed and earn 25 basis points in interest that the Fed charges on reserves. ? A recent analysis by Liberty Street Economics provides the answer. Most of the current Fed funds loans are made by government-sponsored enterprises (GSEs) such as the Federal Home Loan Banks, which have deposits in accounts with the Fed but, unlike private banks, are not credited with interest when they hold balances overnight. The GSEs therefore have an incentive to borrow extra reserves in the Fed Fund market, because 80 cents is better than nothing.
But that raises another question – why don’t other regular banks jump at the chance to borrow fed funds from the GSEs at 8 basis points and then keep the funds overnight in their account at the Fed to earn 25 basis points? Sounds like a risk-free way to make money, right?
One reason more banks aren’t competing to lend these funds may have to do with limits on who the GSEs are willing to lend. Although the risk may be negligible, the potential return is also small, and some banks may not be approved to accept loans from the GSEs. Another factor is that private banks face tougher capital requirements and other regulatory costs as they try to expand their balance sheets. Liberty Street Economics notes that FDIC fees are a prime example of these costs. The FDIC sets an insurance fee based on the bank’s total assets less average tangible equity. If a bank builds its balance sheet by borrowing fed funds and holding them overnight, it can make a profit on the interest rate differential (25 minus 8 basis points), but faces higher insurance fees that eat up much of that profit.
Given regulatory differences in different countries, it is more beneficial for foreign banks to play interest rate arbitrage between the Fed Funds rate and the rate the Fed pays on reserves. The foreign share of the Fed Fund’s lending has increased significantly.
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The Fed Funds rate has therefore gone from one of the most closely watched indicators to one of the least relevant. The fed funds rate today is mainly determined by institutional details of little greater importance. Will we ever go back to the previous system? It’s a long way to go from $2.5 trillion back to $10 billion. It seems to me that there is a good chance that the Fed Funds rate will never return as a key tool in US monetary policy.
A more natural policy tool for when the Fed returns to worrying about short-term interest rates would be the rate the Fed pays on reserves, a quantity the Fed directly controls. If the Fed eventually decides to raise the overnight rate (and that decision, by the way, still seems pretty far off), the natural way to do so would be by raising the rate it pays on reserves.
Another possible Fed policy tool to control short-term interest rates was recently outlined by Simon Potter, Executive Vice President of the Federal Reserve Bank of New York. A standard operation that has been used by the Fed for many decades is a repurchase agreement, or repo, in which the Fed obtains a high-quality asset from one of its primary dealers with a promise from the dealer to buy the asset at a fixed rate. Price a short time later. Essentially, a repo was a secured short-term loan from the Fed to the counterparty. The Fed would make its first payment by creating new deposits from the Federal Reserve, and those reserves would be removed from the system when the assets were returned. The Fed would traditionally implement these transactions in fixed amounts, for example by specifying that they execute $100 million in 3-day repos at a competitively determined market rate. The purpose of such an operation would be to add $100 million in new reserves to the banking system on a purely short-term basis. The reverse operation, referred to by the Fed as a reverse repo, would require the Fed to temporarily transfer some of its assets to the counterparty, and was a tool to temporarily drain $100 million in reserves from the banking system.
Temporarily adding or draining a small amount of reserves in the current environment would of course be completely inconsequential. However, at its September meeting, the FOMC authorized the Federal Reserve Bank of New York to enter into a series of overnight fixed rate reverse agreements with a wide range of counterparties including primary dealers, banks, money market funds and GSEs. Although the initial implementation specified a cap on the total reverse repo volume that could be implemented, the vision is that the ultimate system would be one in which the Fed would temporarily absorb whatever amount of funds the counterparties may decide to hold to the fixed rate. offer, as defined by. Fed. In effect, such a system works like interest on reserves in that any eligible counterparty with excess capital can always earn a certain rate of return by lending to the Fed overnight through a fixed-rate reverse repo. The idea is that because a wider set of institutions is allowed to participate than those that can earn interest on reserves, and because of the collateral nature of the transaction, this would be a more effective way of controlling short-term interest rates than would result. from the simple Change of interest on reserves.
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While the ongoing overnight reverse repo exercise provides us with useful observations that allow us to improve the technical implementation of the policy, our knowledge is naturally limited by the limited nature of the exercise. Important questions remain about the broader money market effects of a fully operational facility. Larger policy and implementation issues will also include whether – and if so how – other tools will be used in conjunction with this facility and [interest on excess reserves] and how the facility might fit into the Federal Reserve’s long-term policy framework. . But while there is still much to learn, the potential addition of an overnight, fixed-rate, full-allotment reverse repo facility offers a promising new technological advance in the conduct of the monetary policy desk.
It remains to be seen what will ultimately become the Federal Reserve’s primary policy tool as short-term interest rates rise above the zero and lower bounds. But I think it’s a good bet that it won’t be the Fed Funds rate.
In any case, for a while it will be helpful to have an alternative to the Fed Funds rate to summarize the stance of monetary policy, for which I recommend the Wu-Xia policy rate as a promising approach. Here is the latest value for their series, which has become more negative since their paper was first circulated.
In other words, the day the Fed actually starts using fixed-rate reverse repos, or some other new policy tool, to raise short-term interest rates is still a long way off. One of the most contentious aspects of this. Tax policy debate in the US today is the appropriate tax level for the wealthy. In the ongoing presidential race, Hillary Clinton is proposing to raise taxes on the wealthy, while Donald Trump is proposing to lower taxes on the wealthy. This policy decision is particularly important because income concentration is at an all-time high
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