Floor System Federal Reserve

Before 2008 the interest rate policy system is a so called corridor system where the discount rate served as the corridor ceiling and the zero lower bound zlb was the floor.

Floor system federal reserve. Mcfadden chairman of the house banking currency committee speech on the floor of the house of representatives june 10 1932. Fed s pre 2008 corridor system. To protect against the floor system s future costs the federal reserve should however restrict its balance sheet policy to bagehot s principles for last resort lending. In a floor system of monetary policy implementation the central bank remunerates bank reserves at or near the market rate of interest.

The truth is the federal reserve board has usurped the government of the united states by the arrogant credit monopoly which operates the federal reserve board congressman louis t. Some observers have expressed concern that operating such a system will have adverse fiscal consequences for the public sector and may even require the government to subsidize the central bank. The federal reserve s floor system can be a drag on economic growth because if set above market rates it will discourage lending and investment and stifle economic activity. Many people know that the federal reserve affects interest rates.

Today s post is the first of a two part series on how the federal reserve influences interest rates. We show that this is not the case. To understand how this new floor system works one must start by recalling that despite its name the federal funds rate is not controlled directly by the federal reserve. To avoid repeating its 2008 mistake the fed does not necessarily need to abandon its use of ioer but it.

To maintain the floor system s present benefits the federal reserve should therefore continue to implement interest rate policy through interest on reserves. However many may not know exactly how the fed does that. In this system the demand curve of the bank reserve market is downward sloping with respect to the interbank interest rate. An article in the regional economist discusses the various interest rates the fed sets.

In my view the case for retaining the current floor system is very compelling for a number of reasons. The stocks of the regional federal reserve banks are owned by the banks operating within that region and which are part of the system. A floor system therefore allows the federal reserve to target a positive price and quantity of reserves simultaneously while holding reserve. A floor system entails the federal reserve purposefully supplying the banking system with more than enough reserves to push the effective federal funds rate down to the interest rate on reserves.

In contrast in a floor system reserves are abundant so that the interest rate the federal reserve pays on excess reserves or ioer is the primary tool used to control the federal funds rate. Instead it is a market rate of interest that one bank charges to another bank on very short term loans of reserves that is funds held on deposit at the fed.