The Federal Reserve determines and carries out monetary policy to promote goals of high employment, sustainable growth, and stable prices. The Reserve tightens monetary policy to curb inflation. It loosens monetary policy to ease unemployment.
There are three basic tools that the Reserve uses to implement monetary policy. Open market operations, discount window operations, and establishing banking reserve requirements.
Open-Market Operations are the purchase and sale of government securities issued by the Treasury Department and sold by securities dealers. It is called Open Market because these purchases are made on the open market from approved securities dealers. Purchasing the securities infuses cash into the banking system by putting the cash into the dealers' own depository banks.
The reserves of these banks are increased which enables them to lend more to consumers or other banks through the federal funds accounts.
The use of open market operations - buying more securities to infuse cash or selling more securities to limit cash - has as the present goal targeting the Federal Funds interest rate. That has not always been the goal. In fact open market operations has not always been the primary tool for monetary policy. It has evolved into its present role since the Depression, focusing at times on the money supply and at times on the Federal Funds Rate.
The primary target now seems to be just bare liquidity.
Have the bank losses from foreclosures, securities, derivatives, credit default swaps, dropped the bank reserves so low as to require these hundreds of billions of dollars just to keep the banking system at its 10% reserve requirement?
Is the Federal Reserve infusing massive amounts of money, by buying securities, simply replacing balance sheet capital that has been lost?
Who has the money that has been lost?
If a home is bought with a loan $100,000 and is foreclosed and sold at $80,000, the home owner has lost a home and the bank has lost $20,000. But has the money supply fallen by $20,000?
The bank has lost $20,000 capital, and therefore cannot make $200,000 in new loans.
Is this the problem that the cash infusion is fighting?
Are there other issues?
In normal times the Federal Reserve uses open market operations to offset normal fluctuations in money supply, technical adjustments to allow for moderate growth and to counter temporary supply fluctuations caused by the normal conduct of business at a national level.
At times the Federal Reserve decides to act to fight unemployment or inflation. To do this the Reserve will increase or decrease open market purchases more than needed for daily technical correction.
The recent infusions though go beyond technical adjustments or even inflation or employment targets.
What is the target? What is the future impact? Have we permanently increased the money supply? Who has the lost money? Will the Federal Reserve need to counter this current cash infusion later with an equally restrictive policy?
Who might know the answers to these questions?
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