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How the Fed Painted Us Into a Corner

BY  ROBERT F. MULLIGAN

 

The Federal Reserve System manages the US’s money supply, increasing or decreasing bank credit and other circulating media to reach a target interest rate usually announced at meetings of the Open Market Committee, which meets eight times a year. They met this week, announcing the first of several modest increases in the federal funds rate. To meet this target, the Fed will lower supplies of monetary aggregates until the federal funds rate reaches the desired target. This will primarily be accomplished by open market sales of US Treasury bonds, bills, and notes by the Federal Reserve Bank of New York.

In order to raise the interest rate, the New York Fed will sell Treasury securities to remove bank reserves from bank balance sheets, and this will have a leveraged effect because any lending based on those reserves will also be removed from circulating as part of the money supply. The greater scarcity of loanable funds held by banks will raise interest rates.

 

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