Fed's Open market operations

Discussion in 'Economics' started by Daal, Dec 4, 2006.

  1. Daal


    Let me see if I understood this. The fed enforces its target for the federal funds through the discount window using repos by outbidding the interest rate of the federal funds when they want to raise it and 'outoffering' when they want to lower it. is this right?
  2. No. The Fed looks at where the Fed Funds contract is trading in order to determine monetary policy.
  3. Daal


    ok but how would they enforce that. fed funds is defined by the 'free' market between banks, I'm not getting the diference between the discount window and open market operations
  4. The Fed's discount window refers to the rate the Fed will lend money to its member banks and is arbitrarily set by the Fed. This is the "Fed funds" rate that is set periodically. This is the rate at which banks borrow to meet their reserve requirements (or more recently, because they'd like to speculate). It is important to note that when this money is borrowed, it is created out of thin air by the Fed.

    Open market operations refers to the trading of bonds. The Fed owns bonds and they may enter into the bond market to buy and sell those securities. It is also important to note that if the Fed decides they'd like to buy bonds, this money is created out of thin air.
  5. In case you're wondering what constrains the Fed from printing all this money "out of thin air"....

    Well.. that would be the public's perception of how drastically the dollar is being devalued. IE. inflation.
  6. Daal


    No, the fed funds rate is negotiated between banks. Money loaned by the fed its the feds discount rate. What I dont understand is why use open market operations why not use the discount window for everything
  7. you're right. that is the discount rate.

    but the discount rate is an arbitrary rate that will not affect the price of bonds. And it's the price of bonds that creates the market interest rate.
  8. Because they can't set the market interest rate directly, they actively enter the bond market to buy and sell. And when they buy, they print the money of out of thin air.