Monday, August 13, 2007

How Does the Fed Inject Money into the Economy? A Primer

Someone was blogging at the WSJ's Real Time Economics on Sunday!

I know I've been off-topic these last few days, If you were looking for a hot stock tip (geothermal? Yuk, yuk, yuk), I apologize. Take a look around the blog though, there might be something that triggers a billion dollar thought for you.

I can't do your thinking for you, I can't do a suitability analysis
("As your investment counsel, I have to ascertain your risk tolerance. Cut the cards for a thousand?").

Everything in finance, economics and investing is interconnected, a lesson I learned to my financial chagrin by not paying attention to the Louvre Accord and its foreseeable effects .
Here's Real Time Econ.:

The Fed garnered attention last week by adding billions of dollars to the money market to relieve upward pressure on interest rates. How do these operations work? Here’s a primer.

The Fed influences growth and inflation by controlling short-term interest rates. It controls those rates in turn via its monopoly over the supply of reserves to the banking system.

All banks in the U.S. are required by law to set aside a portion of their demand deposits (such as checking deposits) as reserves. These reserves can be either currency in the vault, or reserves on deposit at the Federal Reserve. Banks can use reserves at the Fed to settle transactions with each other. Numerous factors affect the level of reserves: funds disbursed for new loans, funds coming in from loan repayments, clearing of checks with other banks, tax payments to the federal government, federal disbursements such as for social security. On any given day, some banks will have more reserves than they need, and others less. Those with an excess lend to those with a shortfall in the federal funds market. The Fed manipulates the federal funds rate by manipulating the supply of these reserves.

Its principal means of doing this is via open market operations. To put downward pressure on interest rates, the Fed would buy securities in the open market from a designated dealer (primary dealer).... More