Among the things our protectionist, isolationist President fails to understand correctly is the role of the Federal Reserve’s policy rate. He wants interest rates to be lower and thinks that the Fed can cause that by lowering its policy rate. That rate used to be the overnight money market rate. If the Fed lowered that target it would supply more money (bank deposits at one of the twelve Federal Reserve Banks) to banks and thus the interbank money market for managing bank liquidity by buying government securities from banks. If banks’ liquidity (“reserves”) is increased, their demand to borrow in the interbank money market will be reduced and thus the interest rate prevailing in that market will be reduced. Thus, raising or lowering the Fed’s policy rate (and the consequent change in base –Fed reserve—money) was the instrument by which the Fed controlled the money supply (its own base money and the more relevant boarder bank money—M1, M2, etc.)
If you are into this subject, you will already understand what money is and where it comes from. If you would like a refresher read this: https://wcoats.blog/2024/11/08/econ-101-money/
The above description of the policy rate was applicable until 2008 when banks held minimal reserves (or excess reserves when there was still a minimum reserve requirement) at the Fed. But in response to the financial crisis in 2008 when the Fed purchased huge quantities of government debt (and mortgage-backed securities), the Fed began to pay banks interest on their now very large deposits at the Fed to keep them from lending them in the market and thus expanding the money supply excessively. So, the relevant Fed policy rate now is the rate it pays on banks’ reserves at the Fed, the so-called Interest on Reserve Balances (IORB).
As with the policy rate in the old regime, the IORB is the instrument by which the Fed now controls the growth in the money supply. When the IORB is reduced below prevailing overnight market rates banks will draw down their Fed deposits to lend at the higher market rate thus increasing money growth.
Interest rates in the market are determined in and by the supply and demand for credit in the market. If the Fed lowers its IORB it will increase the growth rate of dollars. The Fed will do so when it judges that appropriate for achieving its inflation rate target of 2.0 percent. The twelve-month inflation rate in May was 2.4% and rose to 2.7% in June. The Fed decided not to lower the rate further at this time. Doing so could well lead market participants to expect higher inflation in the future, which would raise (not lower) market rates for say 10 year Treasury bills.
Current Fed policy seems appropriate to me. It adheres to an inflation forecast targeting regime that has become popular in recent years in major central banks. But it reacted by raising rates too slowly in response to the surge in inflation in 2021-2 during the Covid pandemic. Inflation reached 9% in mid 2022. A better system is to return control of the money supply to the public that can buy and redeem dollars at a fixed price for a hard anchor (such as a gold standard). I laid this out in the following blog: https://wcoats.blog/2022/06/06/econ-101-the-value-of-money/
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