Monetary Policy Tools

The interest rate the Federal Reserve charges commercial banks and other depository institutions for short-term loans borrowed directly from the Federal Reserve's discount window. One of the three traditional tools of monetary policy (along with open market operations and reserve requirements, which the Board reduced to zero percent effective March 26, 2020), though used less frequently than open market operations for day-to-day policy implementation. Changes to the discount rate signal the Fed's monetary policy stance and can influence overall credit conditions. Note: in time value of money and valuation contexts (NPV, IRR, DCF), "discount rate" instead means the required rate of return used to convert future cash flows to present value, an unrelated concept covered under Required Rate of Return.

Example: When the Federal Reserve wants to signal tighter monetary policy, it may raise the discount rate. Th...

The target interest rate range set by the Federal Open Market Committee (FOMC) for overnight lending of reserve balances between banks and other depository institutions. The actual rate is market-determined through interbank transactions. The FOMC's target range for it is the main operating target of U.S. monetary policy, and it influences other interest rates throughout the economy. The FOMC holds eight regularly scheduled meetings per year to set the target range, typically adjusted in increments of 25 basis points (0.25%).

Example: In March 2022, the FOMC raised the target range for the federal funds rate from 0%-0.25% to 0.25%-0....

A financial statement showing the Federal Reserve's assets (primarily Treasury securities and mortgage-backed securities purchased through open market operations) and liabilities (primarily currency in circulation and bank reserves). The size of the balance sheet expands during quantitative easing (QE) when the Fed purchases securities to inject money into the economy, and contracts during quantitative tightening (QT) when the Fed allows securities to mature without replacement. The balance sheet grew from approximately $900 billion in 2007 to over $8 trillion by 2022 following multiple rounds of QE.

Example: During and after the 2008 financial crisis (from late 2008 through October 2014), the Fed dramatical...

The buying and selling of U.S. Treasury securities by the Federal Reserve (through the Federal Open Market Committee) to control money supply and influence interest rates. It is a key monetary policy tool and is commonly taught as the most frequently used one, though with reserves now abundant the FOMC moves the federal funds rate by changing the rate of interest the Fed pays on reserve balances. The FOMC meets eight times per year to set policy direction.

Example: When the FOMC observes rising inflation, it may sell Treasury securities to banks and dealers. This ...

The interest rate commercial banks charge their most creditworthy corporate customers, serving as a benchmark for consumer and business loan rates including credit cards, mortgages, home equity lines of credit, and auto loans. Typically set approximately 3% above the federal funds rate. Individual banks set their own prime rates, though most major banks use the same rate published as the Wall Street Journal Prime Rate.

Example: When the Federal Reserve raises the federal funds rate by 0.25%, most banks raise their prime rate b...

A monetary policy tool in which the Federal Reserve buys large amounts of longer-term securities (mainly Treasuries and mortgage-backed securities) to lower long-term rates, typically when short-term rates are near zero. This unconventional tool expands the Fed's balance sheet, injects liquidity, and aims to stimulate economic activity by reducing borrowing costs and encouraging lending and investment.

Example: During the 2008 financial crisis, the Fed launched QE1 in November 2008 and, after cutting the feder...

The percentage of customer deposits that commercial banks must hold in reserve (as vault cash or deposits at Federal Reserve Banks), rather than lending out. Set by the Federal Reserve Board of Governors, reserve requirements were historically used to control money supply and ensure banking system stability. Since March 26, 2020, the Fed has set reserve requirements to 0%, effectively eliminating this as an active monetary policy tool. The Fed now relies primarily on open market operations, the discount rate, and interest on reserve balances (IORB) to implement monetary policy.

Example: Historically, if a bank had $100 million in deposits and the reserve requirement was 10%, it had to ...