How will the Fed actually raise interest rates?

…the Fed has found itself forced to experiment. The immense stimulus campaign that it started in response to the 2008 financial crisis changed its relationship with the financial markets. It has pumped so many dollars into the system that it cannot easily drain enough money to discourage lending, its traditional approach. Instead, the Fed plans to throw more money at the problem, paying lenders not to make loans.

The Fed, embedded in the banking system, has also concluded that working through the banks is no longer sufficient to influence the broader economy. It plans to strengthen its hold by working directly with an expanded range of lenders.

Fed officials have repeatedly expressed confidence that the plan will work.

…And if the new approach does not work at first, Mr. Potter said in a recent speech, then his team of monetary mechanics “stands ready to innovate” until it does.

That is from Binyamin Appelbaum, there is much more detail at the NYT link. Here is one extra bit:

…the Fed plans to pre-empt the market, paying banks 1 percent interest on reserves in their Fed accounts, so banks have little reason to lend at lower rates. “Why would you lend to anyone else when you can lend to the Fed?” Kevin Logan, chief United States economist at HSBC, asked rhetorically.

But there is more to it than that, so here is a primer on overnight reverse repurchase agreements (pdf).  Here is a shorter FAQ.  Time to bone up on this stuff, people…

I consider this an under-discussed topic.


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