How does the Fed influence the economy?
Member banks maintain reserves that they deposit at the Fed. A bank that is short on reserves can borrow the money from other member banks at what is called the “federal funds rate”—or “overnight rate,” since the loans are extremely short-term. The federal funds rate is critical to the economy, and it feeds through to other rates. The overnight rate is one of only two rates that the Federal Reserve controls. When inflation fears are aroused, the Fed increases the fed funds rate (called a “tightening”) in order to slow activity in sectors of the economy, such as housing and automobiles, that are particularly sensitive to interest rates. When the economy slows, the Fed reduces the fed funds rate in order to stimulate activity (“loosening”). The Fed also controls what is called the “discount rate”—which is what the Fed charges banks for loans it makes directly to them. The discount rate is usually close to the fed funds rate. 7) How does the Fed decide whether to tighten or loosen monetar
