Re: Simple Question: How does the Fed control interest rates?

From: Some Guy (bc76_at_midmaine.com)
Date: 09/08/04 

Date: 8 Sep 2004 08:48:52 -0700

cantueso@dieznet.com (cantueso) wrote in message news:<a76725c6.0409040724.64b6a5a4@posting.google.com>...
> zerge@hotmail.com (zerge) wrote in message news:<f0a1621c.0409030845.348902b6@posting.google.com>...
>
> there is a web at
>
> http://snipurl.com/8uyz
>
> it explains everything, even the terminology, and the chapters are small.

Thanks! Great site BTW. I had done alot of searching, but mostly
found a bunch of paranoids spewing FUD about the evils of banks. That
site is informative, and doesn't seem to have an axe to grind.

What I got from reading through that site is this:

The fed controls the interest rate by controlling the money supply.

It decreases the money supply mostly by selling Treasury securities (
Bonds etc ) for money. That money given to the Fed 'dissappears'
from existance, because the Fed considers money to be a liability no
longer backed by Treasury Security assets.

If banks required reserves are 10%, and the Fed sells 1000 dollars
worth of Treasury Securities, then is $1000 * 1/0.1 = $10000 removed
from circulation? Does the money multiplier work in reverse? I bet
it does because the Fed doesn't deposit it anywhere as would any other
entity. The downstream deposits are never created. What is clearing
house drain in the context of the money multiplier?
 
The Fed increases the money supply, mostly by buying Treasury
securities for money. The Fed does not debit an account in order to
pay for these securities, it makes the payment deposit out of thin
air. This is equivalent to printing Federal Reserve Notes even if no
physical printing is done. In exchange for the new money, the Fed
gets Treasury Securities.

Because the Fed targets low interest rates with a low but positive
level of inflation, it would eventually become very rich if it kept
accumulating the Government Debt. But since the interest minus
operating expenses are rebated to the Treasury, any Treasury
Securities held by the Fed are almost interest free loans to the
Government.

When the Fed increases the money supply by buying Treasury Securities,
it buys them at the market rate of interest, and only with the purpose
of increasing the money supply to lower the interest rate. The Fed
can't be forced to buy Treasury Securities from the Treasury so the
Treasury can't 'print money' to pay for stuff.

The Banks supply money. They have capital to lend at interest. The
interest minus their risk and expenses equals their profit from
lending. Although increasing the money supply seems to benefit the
banks dollar volume wise, increasing the supply of money does not
increase demand for the money. The interest rate falls, the lending
volume increases as more people can afford to borrow money, and the
bank's profit margin decreases. The banks become efficient like
Wal*Mart and the price of money experiences deflation.

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