"Socialism for The
"Freedom for the pike is death for the minnows" JK Galbraith, The Affluent
The FED is now doing exactly what all its
many opponents have criticized it for many years.
It is clearly serving the Power Elite, less obviously everyone else. It is printing
and billions of dollars and thereby debasing the currency irreparably. "Fixed
be damned." The Fed is now offers a discount window that
allows investment banks as
well as money-center banks to borrow billions using only mortgage-based securities.
What a bail out? The FED's action expose how much of American capitalism is
crony-based and entirely dependent upon government hand-outs. Something is
wrong when all the job growth this year has come from government employment.
Did the Fed have any choice? Do we want another Depression? Yes, it's not
how much choice the FED has when a major stock brokerage, investment bank or bank
suddenly comes to it and says "help us" or "we must shut our doors and not
commitments? And that is what Bear Stearns told the Feds over the
But the Feds loans are unconditional. So, Americans have no
assurance that these
these loans ever will trickle down to working people or prevent a further financial
There is nothing to prevent the banks from increasing executive pay. There is
to guarantee Americans that these same bankers won't make the same mistakes again
and again. And then come back for more hand-outs from the Fed.
Bear Stearns was sacrificed
for the good of the financial market, say the clever pundits.
But it's taxpayer
money that will be used in these bailouts by the Fed to save banks AND the Fed's loans and
bailouts are unconditional.
It is major FED failure that banks are not obliged to make more loans to
homeowners or show that they have learned
anything from their excessive loans (40:1 factoring is not safe!)
to other banks making unsound loans.
no guarantee the Fed's actions will work. $650 billion of the $900
billion dollars worth of FED
reserves set aside for rescue has now been
expended. What happens if home prices keep falling? And that's
very likely. Housing prices in 2005 were
vastly bloated. The FED allowed zero-down housing loans and
a look-the-other-way qualifying process. Why
should they be trusted now? It makes no sense. The FED is
trying somehow to prevent the punctured balloon
from losing all its air and becoming a shriveled-up heap
on the floor. ( The figure of $650
billion was offered by Kudlow, CNBC on 3/18/08. )
If we have not seen a bottom in
housing prices, the FED will have to eat all these mortgages it is letting
its favored banks use as collateral so they
don't default. Actually, it's the taxpayer who will. Then the
Fed will print lots more of its funny money.
The dire effects of the the collapse of the Dollar will be felt
for many years, just as the Bush-Cheney
subsidizing private contractors in Iraq will. A trillion dollars here.
A trillion dollars there. It all adds up.
Perhaps, the FED has $20 billion now in Gold. That's not nearly
enough to create even a modicum of confidence.
We better learn Chinese..
The regulatory system must
prevent the stupid, greedy, fraudulent and bad faith loans and risk taking.
to do this gives the bank license to be
thoroughly corrupt. It allows and encourages predatory lending to the
broad public and extravagant subsidizing of the
undeserving well-connected. In this unregulated arena
bankers become crooks. Arrogance and
incentives all push them in this direction. They readily indulge in
insider trading. Their salaries are
obscenely underserved. And if they are not stopped, penalized and jailed,
in a few years these same crooks will be doing
the same thing all over again. And they will be making political
campaign contributions to gain immunity and
(Added: 3/20/2008 from Nightly Hotline) Will
Their Gamble Backfire?
Confidence in the Fed is going to start slipping badly if
their big gamble here
does not pay off. The Fed has now used up much of its ammunition, too
If anything like a normal market had existed, the DJI today would have been able to
follow-through and get up to its 2.5% upper band. Instead, the rally was
at its steep downtrend. Now one must wonder if the FED has wasted $650
True, they had to do something. But, it looks to me that they have tried to
decline too early. Housing prices are still inflated by the zero-down buying
The mortgage market is a trillion dollars' market. The FED can't stop this market
from going where it needs to. And Congress won't either. Iraq has wasted a
dollars. The Treasury is bare. I think that the stock market needs naturally
after a five year run. The FED can't hold it up, except artificially and temporarily
at these levels.
The Fed naturally does not want to become the center of
attention in a Presidential
Election Year. But its recent actions may backfire and threaten its
Fed clearly want to hold things together until Bush is safely out of office. Next
it will have no ammunition left at the rate its going. In proceeding as it is,
the Fed is going
to become a political target, because its actions look corrupt, JPM favoring and partisan.
Why didn't they just buy the mortgages from the banks, instead of letting banks
use them as collateral? The banks are being treated like royalty. And the Fed
no conditions on the banks. They can make as many, or as few ,loans as they wish
to homeowners now. They are 100% free to make the same mistakes all over
The appearance of corruptness in the banks' bailout just amplifies the popular distrust
with Bush and Cheney's use hundreds of billions from the US Treasury to benefit private
contractors in Iraq. This will bring much more public controls of the Fed,
Wall Street will
not like this. Foreigners will surely start to slow down their loans dramatically to
country perceived to be so corrupt. Harsh? Confidence is a matter of
perception. And the
declining US market will be seen as proof of the corruption. This means bad things
US stocks and the US Dollar. "Foreign buyers of 10-year Treasury Notes
to 5.8%, from an average 25% over the last eight weeks, which is a certifiable
Finally, "Socialism" for the rich is, of course, a misnomer. Socialism
aims at democratically-controlled
public ownership of the means of
production. What we see now is magnificently massive corruption
that benefits only a few.
Am I ranting. Here is what you hear from well-respected people
about these one-sided bailouts.
Willem Buiter, a former Bank of England Policy Maker.
"Still, some economists said, the Fed may encourage risky behavior by
institutions. Willem Buiter, a London School of Economics professor and former Bank of
policy maker, called the Fed's move ``socialism for the rich, which is both inefficient
"The recent bailout (and yes, bailout - that is how the Nightly Business Report
called it) is just
another example of capital extraction from the tax payer. I ain't no bandaid, but as far
as I can tell
here is how the game goes.
Guy X puts all his money on red 23. Black 12 comes up.
Wait, we can't afford for Guy X to go bankrupt! So let's all chip in to help a man
out who is down on his luck.
"Can someone answer this question for me? Why is risk only transferred from company
to company and, then finally, the taxpayer? Can't we force risk exposure on the
that performed these transactions? If Alan Schwartz from Bear Stearns wants
socialism to save his
company, it seems to me only justified to seize his personal property to ensure the Great
- right? (/mild sarcasm).
Jim Rogers: 'Abolish the Fed'
Reserve Chairman Ben Bernanke should resign and the Fed should be abolished as a way to
boost the falling dollar and speed up the recovery of the U.S. economy, investor Jim
CEO of Rogers Holdings, told CNBC Europe Wednesday. Asked what he would do if
in Bernanke's shoes, Rogers, who slammed the Fed for pouring liquidity in the system and
mortgage-backed securities as guarantees, said: "I would abolish the Federal Reserve
and I would resign."
If this happened, "we don't have anybody printing money, we
don't have inflation in the land, we
don't have a collapsing U.S. dollar," he told "Squawk Box Europe."
"No country in the world has ever succeeded by debasing its currency," he said.
"That's what this
man is trying to do. He's trying to debase the currency as a way to revive America. It has
worked in the long term or the medium term....The Fed's move to accept risky collateral is
of the central bank's business, he added. "What
is Bernanke going to do? Get in his helicopter
and fly around the world and collect rents? That's absurd," Rogers said.
"Listen, investment banks
have been going bankrupt since the beginning of time. If people make mistakes -- if you
every investment bank that gets in trouble, that's not capitalism, that's socialism for
the rich," he said.
The weakest financial institution is Fannie Mae, in Rogers'
opinion, "but all of them have problems."
Jim Grant - NY Times
""Now comes the bill for that binge and, with it, cries for even greater federal
oversight and protection.
Ben S. Bernanke, Mr. Greenspans successor at the Fed (and his loyal supporter during
hysteria), is said to be resisting the demand for broadly lower interest rates. Maybe he
is seeing the light that
capitalism without financial failure is not capitalism at all, but a kind of socialism for the rich."
Times of London - :the threat is now insolvency, not
"If it looks like a bail-out, and sounds like a bail-out, it is a bail-out. But
capitalism without failure
is like religion without sin. It doesnt work, says Carnegie Mellon professor
Allan Meltzer. Guarantee
lenders against failure and they will lend and lend and lend, diverting resources to
driving down productivity and living standards."
There are four problems with all of this: 1) "bad news overwhelms good."
2) "T"he Fed is a tiny player
in the mortgage market. The $200 billion of mortgages Bernanke will be taking on are a
drop in the
ocean that is the $11 trillion mortgage market. And he has only another $400 billion in
notes to play with - if he is willing to have these mortgages make up his entire stock of
3) "So long as house prices continue falling, the value of mortgages will continue
falling. The Fed
cant do much to stop that decline, and we seem to have a long way to go before house
reach some bottom, unsold houses are absorbed, and the market turns up." 4)
home loan rates and credit for mortgage buyers are now higher and tighter than when the
started lowing the Discount rate and extending credit very liberally to banks.
( Source: http://business.timesonline.co.uk/tol/business/columnists/article3558527.ece
"The dollar has clearly been
abandoned and foreigners are starting to bail from dollar-denominated
assets in droves. This is where bailouts, and the hyperinflationary destruction of
the dollar that comes
with them, are leading us, along with miniscule bond rates caused by continual flights to
everyone flees in terror due to rapidly deteriorating market conditions caused by subprime
over-leveraged speculation, fraudulent lending and borrowing, lack of oversight,
confidence, frozen credit markets, an out-of-control money supply, profligate borrowing
as well as an economy destroyed in less than two decades by globalization, free trade,
outsourcing, unrestrained illegal immigration, insane wars for profit and the rampant
unemployment that come from a completely, totally and malevolently mismanaged economy
to the reprobates and sociopaths that run the Fed and our government."
More plebe discussion of rule by the power elite.
"The Fed's cherry picking will
reveal the identities of their fellow elite insiders within the various
components of the financial industry, such as banks, investment banks, broker-dealers,
insurance companies, hedge funds, etc. They will be forced to reveal these insiders
because they, and
all the remaining central banks around the world, are not even close to being big enough
to bail out the
entire system. They will only be able to bail out their crucial insiders within the
troubled financial system,
if they are lucky. Bear Stearns was a primary US government bond broker and was
with many other institutions in the system in terms of counter-party exposure.
The Panic of 1907: Lessons Learned from the Market's Perfect Storm (Hardcover)
F. Bruner (Author), Sean
D. Carr (Author)
Banker J. Pierpont Morgan
DJI - 1902-1909
From 1814 to 1914, the United States saw 13 banking panicsof these, the panic of
among the worst. The 1907 Crash was created by a
perfect storm of negative financial forces:
would add Franklin Roosevelt's public humiliation of "trusts"
"Business consolidators" and
Wall Street advisers were creating large, new combinations through mergers and
the government was investigating and prosecuting prominent executives...The publics
toward business leaders, fueled by a muckraking press, was largely negative."
1) Stock Market and Real Estate Speculation: the DJI doubled between October 894 and
"Inadequate safety buffers. In the late stages of
an economic expansion, borrowers and creditors
overreach in their use of debt, lowering the margin of safety in the financial
2) San Francisco earthquake (1906) Much of the real estate of San Francisco was insured by
London. Payouts to San Francisco drained money from the U.K., which raised interest rates
in the U.S.
3) Bank of England decision to slow the flow of gold to the U.S/
4) A reckless scheme to corner the stock in United Copper which made clear the close
between banks, trusts and brokers.. The October decline began following the collapse of
Copper share prices.
5) Absence of a central banking authority.
6) Plunging stock values March 2007 and then October 2007
7) Injured loan collateral values
8) A general loss of confidence. Undue fear.
9) Checks not honored.
10) Run on Banks: October 21, 2007
Knickerbocker Trust Company, Trust Company of America, and Lincoln Trust Company
11) NY verged on bankruptcy.
12) Financial ruin
( See http://bigpicture.typepad.com/comments/2007/11/the-panic-of-19.html
The situation was saved by an individual, J.P. Morgan, provided the leadership and
to the banking system, the City of New York, and the New York Stock Exchange, He
together leading financiers and banks to halt the decline. He threatened the shorts
with ruin. US
Treasury Secretary George B. Cortelyou announced his formal support for Morgan, offering
provide $25 million dollars in additional liquidity during the crisis.
( See http://www.npr.org/templates/story/story.php?storyId=14004846
Banking chiefs, led by J. P. Morgan, later met at the Jekyll Island Club off the Georgia
to concoct the central-banking scheme that became the Federal Reserve Act of 1913.
Federal Reserve Act of 1913 gives the authority the Fed the power to create money.
the only money mentioned in the Constitution was based on gold, silver (and slaves).
founding fathers did not want the US to fall under the control of a secret consortium of
and dominant international banks.
The Federal Reserve Act
1863, as a means to help finance the Civil
War, a system of national banks was instituted by the National Currency Act. The banks each had the power to
issue standardized national bank notes based on United States bonds held by the bank. The
early national banking system had two main weaknesses: an "inelastic" currency;
and a lack of liquidity.
During the last quarter of the 19th century and the beginning of the 20th century the
United States economy went through a series of financial panics.
A particularly severe panic in 1907 provided the motivation for renewed demands for
banking and currency reform.
The following year Congress enacted the Aldrich-Vreeland
Act which provided for an emergency currency and established the National Monetary Commission to study banking and
|The chief of the bipartisan National Monetary Commission was financial
expert and Senate Republican leader Nelson Aldrich. Aldrich set up two
commissions one to study the American monetary system in depth and the other,
headed by Aldrich himself, to study the European central-banking systems and report on
Aldrich went to Europe opposed to centralized banking, but after viewing Germany's banking system
came away believing that a centralized bank was better than the government-issued bond
system that he had previously supported. Centralized banking was met with much opposition
from politicians, who were suspicious of a central bank and who charged that Aldrich was
biased due to his close ties to wealthy bankers such as J.P.
Morgan and his daughter's marriage to John D. Rockefeller, Jr.
Aldrich fought for a private bank with little government influence, but conceded that the
government should be represented on the Board of Directors. Most Republicans favored the Aldrich Plan,
but it lacked enough support in the bipartisan Congress to pass.
Progressive Democrats instead favored a reserve system owned and operated by the
government and out of control of the "money trust", ending Wall Street's control
of American currency supply.
Conservative Democrats fought for a privately owned, yet decentralized, reserve system,
which would still be free of Wall Street's control.
The Federal Reserve Act passed Congress in late 1913 on a mostly partisan basis,
with most Democrats in support and most Republicans against
The primary motivation for creating the Federal Reserve was to address
banking panics (bank runs).
The Federal Reserve briefly describes the circumstances that led to its creation, the
purpose for creating it, and functions of the system in The Federal Reserve in Plain
- "Just before the founding of the Federal Reserve, the nation was plagued with
financial crises. At times, these crises led to panics, in which people raced
to their banks to withdraw their deposits. A particularly severe panic in 1907 resulted in
bank runs that wreaked havoc on the fragile banking system and ultimately led Congress in
1913 to write the Federal Reserve Act. Initially created to address these banking
panics, the Federal Reserve is now charged with a number of broader responsibilities,
including fostering a sound banking system and a healthy economy."
The purpose and functions of the Federal Reserve include:
- to address banking panics (bank runs)
- to serve as the central
bank for the United States
- to strike a balance between private interests of banks and the centralized
responsibility of government
- supervising and regulating banking institutions
- protect the credit rights of consumers
- maximum employment
- stable prices
- moderate long-term interest rates
- maintain the stability of the financial system and containing systemic risk in financial
- providing financial services to depository institutions, the U.S. government, and
foreign official institutions, including playing a major role in operating the
nations payments system
- national functions
- facilitate the exchange of payments among regions
- strengthen U.S. standing in the world economy
- regional functions within the nation
- to be responsive to local liquidity needs
 Addressing the problem of bank panics
- Further information: bank
run, fractional-reserve banking, and money creation
Bank runs occur because banking systems are usually fractional reserve lending institutions and do not
have enough cash in reserves to give to all of their depositors simultaneously. Bank runs
can lead to a multitude of social and economic problems. The Federal Reserve was designed
as an attempt to prevent this from occurring.
How the Federal Reserve addresses the problem of bank panics is described in The
Federal Reserve System - Purposes and Functions:
- "To address these problems, Congress gave the Federal Reserve System the authority
to establish a nationwide check-clearing system. The System, then, was to provide not only
an elastic currencythat is, a currency that would expand or shrink in amount as
economic conditions warranted but also an efficient and equitable check-collection
of last resort
The Federal Reserve has the authority and financial resources to act as lender of
last resort by extending credit to depository institutions or to other entities in
unusual circumstances involving a national or regional emergency, where failure to obtain
credit would have a severe adverse impact on the economy.
Through its discount and credit operations, Reserve Banks provide liquidity to banks to
meet short-term needs stemming from seasonal fluctuations in deposits or unexpected
withdrawals. Longer term liquidity may also be provided in exceptional circumstances. The
rate the Fed charges banks for these loans is the discount rate (officially the primary
In making these loans, the Fed serves as a buffer against unexpected day-to-day
fluctuations in reserve demand and supply. This contributes to the effective functioning
of the banking system, alleviates pressure in the reserves market and reduces the extent
of unexpected movements in the interest rates.
 Central bank
In its role as the central bank of the United States, the Fed serves as a banker's
bank and as the government's bank. As the banker's bank, it helps to assure the
safety and efficiency of the payments system. As the government's bank, or fiscal agent,
the Fed processes a variety of financial transactions involving trillions of dollars. Just
as an individual might keep an account at a bank, the U.S. Treasury keeps a checking
account with the Federal Reserve through which incoming federal tax deposits and outgoing
government payments are handled. As part of this service relationship, the Fed sells and
government securities such as savings bonds and Treasury bills, notes and bonds. It
also issues the nation's coin
and paper currency. The U.S. Treasury, through its Bureau
of the Mint and Bureau of Engraving and Printing, actually
produces the nation's cash supply; the Fed Banks then distribute it to financial
Federal funds are the reserve balances that private banks keep at their local Federal
These reserve balances are the "reserves" in "federal reserve", hence
the name of the system. The purpose of keeping funds at a Federal Reserve Bank is to have
a mechanism through which private banks can lend funds to one another. This market for
funds plays an important role in the Federal Reserve System as it is what inspired the
name of the system and it is what is used as the basis for monetary policy. Monetary
policy works by influencing how much money the private banks charge each other for the
loaning of these funds.
Balance between private banks and responsibility of government
Private banks are regulated by the government. This means that there are some
restrictions on what private banks are allowed to do. The Federal Reserve is the specific
part of government that regulates the private banks.
 Government regulation and supervision
The Board of Governors is the part of the Federal Reserve System that is
responsible for supervising the private banks. How the system is regulated is described by
the Federal Reserve:
- "The Board also plays a major role in the supervision and regulation of the U.S.
banking system. It has supervisory responsibilities for state-chartered banks
that are members of the Federal Reserve System, bank
holding companies (companies that control banks), the foreign activities of member
banks, the U.S. activities of foreign banks, and Edge Act and agreement
corporations (limited-purpose institutions that engage in a foreign banking business).
The Board and, under delegated authority, the Federal Reserve Banks, supervise
approximately 900 state member banks and
5,000 bank holding companies. Other federal agencies also serve
as the primary federal supervisors of commercial banks; the Office of the Comptroller of the
Currency supervises national banks, and the Federal Deposit Insurance Corporation
banks that are not members of the Federal Reserve System.
- "Some regulations issued by the Board apply to the entire banking industry, whereas
others apply only to member banks, that is, state banks that
have chosen to join the Federal Reserve System and national banks, which by law must be
members of the System. The Board also issues regulations to carry out major federal laws
governing consumer credit protection, such as the Truth
in Lending, Equal Credit Opportunity, and Home Mortgage Disclosure Acts. Many of these
consumer protection regulations apply to various lenders outside the banking industry as
well as to banks.
- "Members of the Board of Governors are in continual contact with other policy
makers in government. They frequently testify before congressional committees on the economy, monetary
supervision and regulation, consumer credit protection, financial
markets, and other matters."
- "The Board has regular contact with members of the Presidents Council of Economic Advisers and other key
economic officials. The Chairman also meets from time to time with the President of the United States and has regular
meetings with the Secretary of the Treasury. The
Chairman has formal responsibilities in the international arena as well."
Tools of monetary policy
There are three main tools of monetary policy that the Federal Reserve uses to
influence the amount of reserves in private banks:
- open market operations - purchases and sales of
U.S. Treasury and federal agency securities--the Federal Reserve's principal tool for
implementing monetary policy. The Federal Reserve's objective for open market operations
has varied over the years. During the 1980s, the focus gradually shifted toward attaining
a specified level of the federal funds rate (the rate that banks charge each
other for overnight loans of federal funds, which are the reserves held by banks at the
Fed), a process that was largely complete by the end of the decade.
rate - the interest rate charged to commercial banks and other depository
institutions on loans they receive from their regional Federal Reserve Bank's lending
facility--the discount window.
- reserve requirements - the amount of funds that a
depository institution must hold in reserve against specified deposit liabilities.
In order to address problems related to the subprime mortgage crisis, two new facilities have
been created. The first new tool, called the Term Auction Facility, was added on December 12,
2007. It was first announced as a temporary tool
but there have been suggestions that this new tool may remain in place for a prolonged
period of time.
Creation of the second new tool, called the Term Securities
Lending Facility, was announced on March 11, 2008.
The main difference between these 2 facilities is that the Term Auction Facility is used
to inject cash into the banking system whereas the Term Securities Lending Facility is
used to inject treasury securities into the banking system.
- Further information: open market operations, money creation, and seignorage
Open market operations put money in and take money out of the banking system. This is
done through the sale and purchase of U.S. government treasury securities. When the U.S.
government sells securities, it gets money from the banks and the banks get a piece of
paper (I.O.U.) that says the U.S. government owes the bank money. This drains money from
the banks. When the U.S. government buys securities, it gives money to the banks and the
banks give the I.O.U. back to the U.S. government. This puts money back into the banks.
The Federal Reserve education website describes open market operations as follows:
- 'Open market operations involve the buying and selling of U.S. government securities
(federal agency and mortgage-backed). The term "open market" means that the Fed
doesnt decide on its own which securities dealers it will do business with on a
particular day. Rather, the choice emerges from an "open market" in which the
various securities dealers that the Fed does business withthe primary
dealerscompete on the basis of price. Open market operations are flexible and thus,
the most frequently used tool of monetary policy.
- 'Open market operations are the primary tool used to regulate the supply of bank
reserves. This tool consists of Federal Reserve purchases and sales of financial
instruments, usually securities issued by the U.S. Treasury, Federal agencies and
government-sponsored enterprises. Open market operations are carried out by the Domestic
Trading Desk of the Federal Reserve Bank of New York under direction from the FOMC. The
transactions are undertaken with primary dealers.
- 'The Feds goal in trading the securities is to affect the federal funds rate, the
rate at which banks borrow reserves from each other. When the Fed wants to increase
reserves, it buys securities and pays for them by making a deposit to the account
maintained at the Fed by the primary dealers bank. When the Fed wants to reduce
reserves, it sells securities and collects from those accounts. Most days, the Fed does
not want to increase or decrease reserves permanently so it usually engages in
transactions reversed within a day or two. That means that a reserve injection today could
be withdrawn tomorrow morning, only to be renewed at some level several hours later. These
short-term transactions are called repurchase agreements (repos) the dealer sells
the Fed a security and agrees to buy it back at a later date.'
A simpler description is described in The Federal Reserve in Plain English:
- "How do open market operations actually work? Currently, the FOMC establishes a
target for the federal funds rate (the rate banks charge each other for overnight loans).
Open market purchases of government securities increase the amount of reserve funds that
banks have available to lend, which puts downward pressure on the federal funds rate.
Sales of government securities do just the oppositethey shrink the reserve funds
available to lend and tend to raise the funds rate.
- By targeting the federal funds rate, the FOMC seeks to provide the monetary stimulus
required to foster a healthy economy. After each FOMC meeting, the funds rate target is
announced to the public."
- Further information: repurchase agreement
To smooth temporary or cyclical changes in the monetary supply, the desk engages in repurchase
agreements (repos) with its primary dealers. Repos are essentially secured, short-term
lending by the Fed. On the day of the transaction, the Fed deposits money in a primary
dealers reserve account, and receives the promised securities as collateral.
When the transaction matures, the process unwinds: the Fed returns the collateral and
charges the primary dealers reserve account for the principal and accrued interest.
The term of the repo (the time between settlement and maturity) can vary from 1 day
(called an overnight repo) to 65 days.
 Federal funds rate and discount rate
- Further information: federal funds rate and discount rate
The Federal Reserve System implements monetary
policy largely by targeting the federal
funds rate. This is the rate that banks charge each other for overnight loans of federal funds,
which are the reserves held by banks at the Fed. This rate is actually determined by the
market and is not explicitly mandated by the Fed. The Fed therefore tries to align the
effective federal funds rate with the targeted rate by adding or subtracting from the
money supply through open market operations. The late economist Milton
Friedman consistently criticized this reverse method of controlling inflation by
seeking an ideal interest rate and enforcing it through affecting the money supply since
nowhere in the widely accepted money supply equation are interest rates found.
The Federal Reserve System also directly sets the "discount rate", which is
the interest rate that banks pay the Fed to borrow directly from it. This rate is
generally set at a rate close to 100 points above the target federal funds rate. The idea is to
encourage banks to seek alternative funding before using the "discount rate"
Both of these rates influence the prime rate which is usually about 3 percentage points higher than
the federal funds rate.
Lower interest rates stimulate economic activity by lowering the cost of borrowing,
making it easier for consumers and businesses to buy and build, but at the cost of
promoting the expansion of the money supply and thus greater inflation. Higher interest
rates slow the economy by increasing the cost of borrowing. (See monetary
policy for a fuller explanation.)
The Federal Reserve System usually adjusts the federal funds rate by 0.25% or 0.50% at
The Federal Reserve System might also attempt to use open
market operations to change long-term interest rates, but its "buying power"
on the market is significantly smaller than that of private institutions. The Fed can also
attempt to "jawbone" the markets into moving towards the Fed's desired rates,
but this is not always effective.