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September 13, 2007

The Fed's tools

The Federal Reserve has been in the news a lot recently. The bank intervened in the economy to stabilize the financial sector after big drops in the stock market. N.C. State University economist Mike Walden outlines the tools that the Fed can use.

"They have a combination of tools. They have two tools that relate to interest rates -- one tool related to the money supply, or the credit supply. What the Fed did recently was lower one of the interest rates. It's called the discount rate," explains Dr. Walden, a professor of agricultural and resource economics. "That's the rate the Federal Reserve charges directly to banks if banks want to come to them to borrow money. The Fed lowered this because they were worried that some banks and some other financial institutions perhaps were ... facing a money crunch where they simply wouldn't have enough money available to meet their demand, and so the Fed lowered this interest rate. It's called the discount rate.

"Now the interest rate that gets more news and affects other rates in the economy called the federal funds rate," he adds. "The Fed did not lower that; however, they are effectively lowering it because they have been supplying more money and credit to the economy and as they do that that actually causes the federal funds rate to go down. And we've actually seen a drop in the federal funds rate of at least a quarter percent in recent weeks. Now the Fed can stop doing that when they stop supplying extra money to the economy.

"So there's more that the Fed can do than just the headlines that we read. Behind the scenes they've actually been acting to make all credit more available," he concludes.

Posted by deeshore at September 13, 2007 08:00 AM

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