Friday, June 26, 2009

Further on the Fed

To follow up on yesterday's discussion of the Fed meeting, there are of course other functions of the Federal Reserve in addition to the Federal funds rate. It also sets the discount rate, which is the interest rate that banks pay the Fed to borrow directly from it, commonly called the discount window. (The Fed funds rate, remember, is the rate at which banks borrow, short-term, from each other.) The discount rate is usually about 1 percent above the Federal funds rate; right now it's at 0.5 percent.

The Fed can also raise or lower requirements for the reserves that member banks have to keep on deposit. The more money a bank needs to keep in reserve, the less it has to lend out. One reason banks take advantage of these short-term lending policies is to meet their reserve requirements.

Those are the basic tools the Fed uses to manage the country's monetary policy, to spur on the business cycle, tamp down inflation, or whatever else it sees as necessary to our economy. In the past, it was also responsible for dealing with panics and runs on banks, which thankfully we haven't had to worry about lately.

The fact that they didn't deem it necessary to tinker with any of these policies at this point, as we said, is heartening.

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