Can the Fed do anything to save our economy?

• Author: Adams, Tucker Hart
• Position: The ECONOMIST

IT'S BEEN ALMOST TWO YEARS SINCE I'VE written about the Federal Reserve, quantitative easing and all of that fascinating stuff. (I know, I know, but remember that monetary theory was one of' my fields of specialization in graduate school.) It is time to address that topic once more, now that the Fed has announced it twill continue to purchase securities and keep short-term interest rates close to zero.

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I'm sure you remember that the Fed's mission is to provide maximum employment and stable prices. And that it has three primary tools with which to do this - open market operations, discount window lending and setting reserve requirements. Of these, open market operations are the most important.

Just in case you've forgotten, open market operations are the buying and selling of' U.S. government securities in the open market. The Federal Reserve Bank of New York carries out these operations by trading U.S. government and select other securities with 21 designated primary dealers such as J.P. Morgan and Credit Suisse.

The Fed doesn't actually set interest rates. But since the interest rate moves in the opposite direction of the price of a security, when the Fed buys securities, the price rises and the interest rate falls. When it sells securities, the price Us and the interest rate rises. It's no different from the market For oil or wheat, except for one detail. When the Fed needs money to purchase securities, it creates it. When it receives money from the sale of securities, it destroys it.. That's a bit of an oversimplification, but generally correct. it's how the Fed "controls" the money supply.

Usually the Fed focuses on the federal funds rate, which is the interest rate at which depository institutions lend balances to each other overnight. The Federal Open Market Committee establishes the target rate for trading in the Federal funds market. If they want lower rates they buy securities, the primary dealers deposit the hinds in their commercial bank account, banks have more funds to lend other banks, and the fed funds rate falls.

For many months the target for the fed funds rate has been 0 percent to 0.25 percent, and banks are flush with funds. But, because of the uncertainty in the economy, this money isn't being loaned, invested in business...