How can the Fed Reserve Bank actually change interest rates?

If the Bank lends out more money at below market interest rates, all this money has to come from somewhere, it has to borrow the money, which will drive up interest rates as much as they are trying to lower them. If the Bank tries to change interest rates by buying or selling Treasury bonds, this will just cause inflation/deflation, counteracting the intended effect. The interest rate might change, but the inflation-adjusted interest rate (which is what really matters) will not. The only thing the bank has control over is inflation. Similarly, if the bank reduces lending, it can be viewed that the increase in interest rates come about merely because of the deflationary pressure of this decrease in money supply, and so the inflation adjusted interest rate again will not be changed.

All this should not be surprising; there is no "free lunch". The Fed is just moving money around, from one place to another, and this cannot affect market interest rates. The only influence the Fed has over the economy is inflation, and its combined interplay with government taxation.

 

A couple of ways, first through open market operations the fed can increase and decrease the supply of money by buying and selling Government securities (such as bonds). Also, this isn't to be confused with the Federal Funds rate, which is the rate of interest that the Fed charges member banks for loans. There is no such thing as "market interest rates", interest is nothing more than the perceived time value of money combined with the risk of default.

 

What do you mean by "this isn't to be confused with the Federal Funds rate?" When the Fed engages in open market operations, the Fed Funds rate is exactly what they are targeting. Interbank lending is used frequently by banks when they are looking for liquidity, and that is directly affected by the Fed funds rate. Hence why it has an impact on market rates.

Also, what do you mean by "there is no such thing as market interest rates?"

BTW - market rates are based on more than just default risk - i.e. inflation risk, volatility of the return of the underlying investment, liquidity premium, cost of capital, etc.

 

Apparently the Fed are buying into mortgage-backed securities now as well.

 

Sounds GREAT!!! What could possibly go wrong?

 

My whole point of this thread was that this doesn't actually change interest rates, since this money has to come from somewhere else.
To "expand the money supply", the Reserve Bank has to either buy assets and/or cause inflation. Doing either of these will cause real interest rates to go up.

So it should be obvious that real interest rates (adjusted for inflation) within an economic system cannot be changed just by shifting around a bunch of paper.

 

My whole point of this thread was that this doesn't actually change interest rates, since this money has to come from somewhere else.
To "expand the money supply", the Reserve Bank has to either buy assets and/or cause inflation. Doing either of these will cause real interest rates to go up.

So it should be obvious that real interest rates (adjusted for inflation) within an economic system cannot be changed just by shifting around a bunch of paper.

 

You got it....The Fed is government control over an economy eternally suspended between boom and bust while the Fed manipulates interest rates in perpetuity based on their market projections. Remember the crash of 1929 happened AFTER the Fed was established.

 

The machinations of the Federal Reserve are much more nuanced than this. First, as Random_Variable stated, the Federal Reserve uses OMOs to target the federal funds rate. This rate is not arbitrarily set.

Second, there are certainly market interest rates. I suggest referring to the parameters and workings of the liquidity preference model to better understand this matter.

 

There is much more to market interest rates other than liquidity preference.

 

I concur. The liquidity preference model is a springboard upon which greater research can occur.

 

And, with the exception of the rare financial crisis like we had recently, the Fed doesn't really loan out that much money. OMC interventions control interterest rates, not Fed lending.

 

It will cause short term rates to go down. The perception of higher inflation would cause long term lenders to charge higher rates. The fact that we haven't seen signficant increases in long term loan rates is because, outside the rabble of Austrian libertarians who frequent boards like this, most do not expect there to be a big inflation issue.

You are correct that there is a limit to how much the Fed can add to the money supply before inflation start to have a greater effect.

 

The Fed was created beasue there were so many panics and crashes so often.

It is tru 1929 happened after the Fed, which reflects that the science of money management was not very well developed, and the fact that the Fed was obligated to maintain a gold standard until 1934.

 

Not to mention the fact of abuse of private currencies by companies against their workers.

 

There is no inflation by lowering interest rates, because banks are not losing enough money to warrant a rise of interest rates at the moment.

Inflation signs would be visible when the banks stop giving out loans, which they haven't, they are still making money with those lower interest rates

This is merely a pay cut by the government, to the banks, until they get their acts together and do what the socialists say.

 

Okie dokie.

 

I'm not that familiar with that bit of history but it would be interesting to know.

 

I chose my words poorly. I merely meant to suggest that they aren't the same thing and you're absolutely correct that it's via the OMO that the rate is controlled.

I'd have been more correct to say -- "The Federal Open Market committee meets to determine interest targets an uses open market operations to reach those goals"

I didn't like the way it was used by the OP, it was as if he was trying to imply there is a single market interest rate, there is certainly one that is most common on cash deposits, but the rates vary depending on the investment we're discussing

It most certainly does, the most obvious way to show this would be to point to rates that are tied to the fed rate.

You're right, but I'm a layman and that was my plain language attempt at arguing against the OP's assertion that the Fed can't control interest rates and provide an example of how that's accomplished. As I mentioned in my reply to RV, I merely meant to disambiguate the two, yes one is used to control the other but they can't be used interchangeably.

It was the nuance of a market interest rate, versus market interest rates. True, there is a rate common to particular types of deposits but there are many rates and they vary.

 

I'd also add the lack of deposit insurance, knowing your deposits are secure almost (so far so good) eliminates the threat of a run.

 

Great point.

.............

 

Why do banks need to be forced to buy deposit insurance? I have no problem with a centralised body offering deposit insurance (assuming it is not being subsidised under ordinary conditions, and charges premiums about equal to the actual risk). But perhaps it should be optional. If bank depositors want a guarantee from the government, they should get slightly lower interest rates.

Either that, or people do not realise how much real value the dollar as actually lost. Expanding the money supply may likey not be greating the gradual inflation one would typically expect, rather it could be creating a new "bubble" - a dollar bubble. The actual inflation will come suddenly and unexpectedly, it will be precipitated by a panic. The dollar has been gradually hollowed out like a wooden beam with a terminte infestation. It is only a matter of time before it collapses.

Have any of those geniuses on Wall Street actually tried to calculate how much the dollar is inherently worth now, and whether it is under or overrrated? I doubt one of them has seriously taken a look at the Reserve assets being held by the central banks to back the dollar.

 

http://abcnews.go.com/blogs/business/2011/11/fed-gave-banks-trillions-in-bailout-bloomberg-reports/


This is the million dollar question right here.

Where did the FED come up with the 1.2 Trillion dollars it loaned in one day?

Perhaps when people realize the treasury can't print money without congressional approval, and that it is a act of treason to do so, people will understand why so many from Ron Paul to Bernie Sanders call for a 3rd party audit of the FED!

 

Money supply management is inherently not a science. It wasn't, isn't, and never will be.

 

And I'd like to add, that the existence of deposit insurance has created an unsustainable level of moral hazard & has been a catalyst for excessive risk taking by both banks and depositors, as it has taken away much of the incentive to deposit money in "safer" banks.