{"id":68,"date":"2025-05-08T07:37:34","date_gmt":"2025-05-08T11:37:34","guid":{"rendered":"https:\/\/people.bsu.edu\/econbriefs\/?p=68"},"modified":"2025-05-22T07:55:49","modified_gmt":"2025-05-22T11:55:49","slug":"the-feds-new-favorite-tool-by-dr-cecil-bohanon-and-dr-john-horowitz","status":"publish","type":"post","link":"https:\/\/people.bsu.edu\/econbriefs\/2025\/05\/08\/the-feds-new-favorite-tool-by-dr-cecil-bohanon-and-dr-john-horowitz\/","title":{"rendered":"The Fed\u2019s New Favorite Tool \u2013 by Dr. Cecil Bohanon and Dr. John Horowitz"},"content":{"rendered":"<p><em>Originally written on 4\/25\/2023<\/em><\/p>\n<p><span data-contrast=\"auto\">A few weeks ago, Ball State&#8217;s Economics Club took ten undergraduate students on a Spring Economic field trip to St. Louis, Missouri. The group visited a social service agency, two universities, the City Museum, and a St. Louis Cardinals baseball game (sadly, the Redbirds lost). The group also visited the St. Louis Federal Reserve Bank (Fed). We learned that before 2008 the Fed mainly managed monetary policy through open-market operations. Since 2008 the Fed primarily manage monetary policy by paying interest on excess reserves held by member banks.\u00a0<\/span><span data-ccp-props=\"{&quot;201341983&quot;:0,&quot;335559740&quot;:480}\">\u00a0<\/span><\/p>\n<p><span data-contrast=\"auto\">The money supply is the cash the public holds, plus their deposits in <\/span><a href=\"https:\/\/fred.stlouisfed.org\/series\/M2SL\"><span data-contrast=\"none\">checking accounts at commercial banks plus other liquid deposits<\/span><\/a><span data-contrast=\"auto\">. Open-market operations are when the Fed increases or reduces the nation&#8217;s money supply by\u00a0 buying or selling government bonds. Suppose the Federal Reserve buys $1 million in U.S. Government bonds. They issue the bond owner a check drawn on the Federal Reserve Bank for $1 million. The former bond owner deposits this in her checking account, and the money supply rises by $1 million. Moreover, the bank that received her deposit can loan out a portion of this newly created money, further expanding the money supply. Curious students often ask where the Federal Reserve Bank gets the original million dollars. The answer is that the Fed creates the money out of thin air! That&#8217;s the incredible power of a Central Bank.\u00a0<\/span><span data-ccp-props=\"{&quot;201341983&quot;:0,&quot;335559740&quot;:480}\">\u00a0<\/span><\/p>\n<p><a href=\"https:\/\/www.federalreserve.gov\/faqs\/why-is-the-federal-reserve-paying-banks-interest.htm\"><span data-contrast=\"none\">In 2008, the Federal Reserve started paying member banks interest on the excess reserves they hold at the Federal Reserve<\/span><\/a><span data-contrast=\"none\">.<\/span><span data-contrast=\"auto\"> Two things happened. First, it shored up the banking system. The Fed injected new reserves into the system, <\/span><a href=\"https:\/\/www.frbsf.org\/education\/publications\/doctor-econ\/2013\/march\/federal-reserve-interest-balances-reserves\/#:~:text=Essentially%2C%20paying%20interest%20on%20reserves,interest%20rate%20on%20excess%20reserves.\"><span data-contrast=\"none\">and the paid the banks interest if they sat on the money with the Fed. And banks did just that.<\/span><\/a><span data-contrast=\"auto\"> As someone said, it made banking easy. Where does the Fed get the money to pay the interest? Same as above, out of thin air.\u00a0<\/span><span data-ccp-props=\"{&quot;201341983&quot;:0,&quot;335559731&quot;:720,&quot;335559740&quot;:480}\">\u00a0<\/span><\/p>\n<p><span data-contrast=\"auto\">But second, and as important, this interest rate became the Fed&#8217;s go-to tool to manage the economy. When the Fed raises the interest rate paid on bank deposits, banks are less likely to loan out excess reserves cooling down the economy. When the Fed lowers the interest rate on bank deposits, banks are more likely to loan out reserves, revving up the economy. Has it been more effective? Our recent inflation experience says not particularly. But it is a change our students and readers should know about.\u00a0\u00a0<\/span><span data-ccp-props=\"{&quot;201341983&quot;:0,&quot;335559731&quot;:720,&quot;335559740&quot;:480}\">\u00a0<\/span><\/p>\n","protected":false},"excerpt":{"rendered":"<p>Originally written on 4\/25\/2023 A few weeks ago, Ball State&#8217;s Economics Club took ten undergraduate students on a Spring Economic field trip to St. Louis, Missouri. The group visited a social service agency, two universities, the City Museum, and a St. Louis Cardinals baseball game (sadly, the Redbirds lost). The group also visited the St. [&hellip;]<\/p>\n","protected":false},"author":112,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[718],"tags":[380,676,731,722,727,147,490,726,257,719,729,7,725,397,728,730,721,114,724,720,723],"class_list":["post-68","post","type-post","status-publish","format-standard","hentry","category-fed","tag-ball-state-university","tag-bank","tag-central-bank","tag-city-museum","tag-commercial-bank","tag-economics","tag-economics-club","tag-excess-reserves","tag-federal-reserve-bank","tag-field-trip","tag-government-bonds","tag-inflation","tag-interest","tag-interest-rate","tag-liquid-deposit","tag-loan","tag-missouri","tag-monetary-policy","tag-open-market","tag-st-louis","tag-st-louis-federal-reserve-bank"],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v27.7 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>The Fed\u2019s New Favorite Tool \u2013 by Dr. Cecil Bohanon and Dr. John Horowitz - Econ Briefs<\/title>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/people.bsu.edu\/econbriefs\/2025\/05\/08\/the-feds-new-favorite-tool-by-dr-cecil-bohanon-and-dr-john-horowitz\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"The Fed\u2019s New Favorite Tool \u2013 by Dr. Cecil Bohanon and Dr. John Horowitz - Econ Briefs\" \/>\n<meta property=\"og:description\" content=\"Originally written on 4\/25\/2023 A few weeks ago, Ball State&#8217;s Economics Club took ten undergraduate students on a Spring Economic field trip to St. Louis, Missouri. 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