“Senior Fed officials believe they will be able to push up the fed-funds rate, the traditional benchmark for short-term interest rates, but not by the usual means of simply selling relatively small amounts of Treasury securities to soak up bank reserves.
Instead, they are looking at a new tool, raising the interest rate that the Fed pays banks on cash kept on reserve with the central bank.
When the Fed decides to tighten, the plan is to raise that rate from its low level of 0.25%. Because no bank will lend to another bank at a rate lower than it can get at the Fed, increases in interest paid on reserves will, the Fed figures, pull up the fed-funds rate—and with it other short-term rates. It will also soak up some reserves with technical operations, such as a practice called reverse repos in which the Fed lends out Treasury bonds.” Read more.
“Markets Get Ready to Navigate Fed’s Departure”
Wall Street Journal, April 25, 2011.
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