Question

9 As of 2020, the Federal Reserve Bank has "total control of the Fed Funds Market. They tell banks exactly what they can and can't do in this private market. The banks must follow the orders of the Fed and they can't lend money to each other without the Fed's permission. True or False 02:15:00 Skipped False True

Answer 1

The statement in question is false!!

The Fed rather than strictly controlling banks and deciding to whom they will led or not, creates incentives for banks to follow what Fed wants them to do. In order for the banks to follow what Fed wants them to do Fed uses Open market operation as follows:

1. If Fed wants to increase Fed funds rate (FFR): In order to do so, Fed conducts open market operations therefore it sells securities to banks and removes credit from their balance sheet. As a result, banks required reserves falls short what it is required to make reserves. This will increase demand of funds in the market (borrowing between banks will increase) leading to increase in Fed Funds rate.

2. If Fed wants to decrease Fed funds rate (FFR): In order to do so, Fed conducts open market operations therefore it buys securities from banks and provides them credit . As a result, banks required reserves increases what it is required to make reserves. This will increase supply of funds in the market (lending between banks will increase) leading to decrease in Fed Funds rate.

Therefore Fed funds market functions based on what inducements Fed has created rather than some strict regulations made by Fed.

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