The Fed engages in Open Market Operations(OMOs) to control the money supply in the economy. By selling securities, money supply is contracted putting an upward pressure on interest rates, investment and consumption in economy is lowered and this slows down economic growth and vice versa. Banks and financial institutions are the main customers of government securities, therefore, lending and investment in economy is very responsive to OMOs. (Pride, Hughes & Kapoor, 634). Conducting OMOs is mainly to influence “the interest rate paid by a bank to borrow funds from another bank [i.e. federal funds rate]” (Pride, Hughes & Kapoor, 635). In the context of the article bringing about control measures in credit market serves two purposes of the Fed. It alleviates the harm caused by dysfunctional credit markets and reduces the pressure off lower interest rates, that the Fed has been using recently to fuel the slacking economy.
The article states “before this week’s liquidity actions, financial markets expected another three-quarter point cut at the Fed’s next rate-setting meeting on March 18th”(Plugging Holes). Reviewing the latest Federal Open Market Committee(FOMC) press release confirms this expectation “the Board of Governors unanimously approved a 75-basis-point decrease in the discount rate to 2-1/2 percent and lower its target for the federal funds rate 75 basis points to 2-1/4 percent” (FOMC Press Release). This comes in the midst of inflationary pressures that are devaluing dollar and increasing commodity prices. Inflation is resulting from the increase in money supply generated through lowering of discount rate i.e. “the interest rate Fed charges for loans to member banks” (Pride, Hughes & Kapoor, 635). As lower discount rates increase money supply, decrease real interest rates and increase investment and consumption in the economy.
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