Interest on Reserves (IOR) and Overnight Reverse Repurchase (ON-RRP) RateConsider the following conversation between Teresa, a teaching assistant, and Neha and Sam, students in her Economics class.
TERESA:
Nowadays, the Federal Reserve can influence household spending, business investment, production, employment, and inflation in the United States. Could someone explain how the Fed manages the interest rate levels?
NEHA:
The Fed does so by changing .
SAM:
In order to do this, the Fed changes and .
TERESA:
Suppose the current federal funds rate is 1.50% and the Fed wants to raise it. What should the Fed do?
NEHA:
The Fed needs to set the IOR rate the current federal funds rate, say, to .
TERESA:
Please identify which of the following accurately explains the effect of this strategy by the Fed?
Banks will borrow reserves in the federal funds market at 1.50% and place those reserves on deposit with the Fed to earn 2.00%.
Banks will remove the reserves they hold with the Fed that earn 1.00% and lend out those reserves in the federal funds market to earn 1.50%.
SAM:
As a result, reserves in the federal funds market , pushing the federal funds rate.
TERESA:
What is the main objective of the ON-RRP rate?
NEHA:
The primary objective of the ON-RRP rate is to priovide a for short term interest rates, ensuring that they do not the target set by the Fed.
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