Interest rate tools available to a central bank

written by: Marina Moore; article published: year 2006, month 09;

In: Root » Legal and finance » Wealth building

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The most frequently employed interest rate policy tools used by theFed are:

  • open market operations: The Fed can buy or sell Treasury securities, thereby changing funds available in the economy. For example, when Treasury securities are purchased by the Fed, funds are added to the market.
  • changing the discount rate: The Fed can change the rate at which banks can borrow from the Fed's discount window. This is also the rate at which banks borrow from each other. For example, increasing the discount rate makes the cost of funds more expensive for banks; the cost of funds is reduced when the discount rate is lowered.

Less frequently used tools are:

  • changing bank reserve requirements: By changing reserve requirements on banks, the Fed can influence the funds available for lending in the banking system.
  • verbal persuasion: The Fed can ask banks to change their lending policies to supply credit to businesses and consumers and consequently affect interest rates.

Together these tools can raise or lower the cost of funds in theeconomy.

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