New framework
After the Fed's unconventional response to the Financial Crisis of 2008-2009 and its aftermath, traditional ways of conducting monetary policy "dried up." The New Framework is a response to this problem where the following tools will be used in conjunction with each other in order to influence market interest rates and conduct monetary policy pursuant to the Fed's Dual mandate of price stability and maximum employment. The tools of the New Framework consists of the following, with brief descriptions provided:
Policy begun by Fed in late 2008 in which interest is paid on reserves held at the Fed that exceed the mandated level of reserves. While it was instituted for several reasons, its primary theoretical use is to act as a "floor" for the fed funds rate. Prior to the Financial Crisis, the Fed could easily control the inter-bank fed funds lending rate by simply adding or subtracting reserves via traditional monetary policy tools (e.g. open market operations, etc.). However, in response to the crisis and the implementation of many unconventional policies (such as quantitative easing), the financial system has an enormous oversupply of reserves, putting relentless downward pressure on the fed funds rate (higher supply = lower "price of money", i.e. interest). This poses a problem for when the time comes for the Fed to end its accommodative monetary policies and begin the process of "tightening", as the large quantity of reserves severely limits its ability to match the effective fed funds rate to the target fed funds rate without a significant withdrawal of reserves. This is where IOER comes it; theoretically, banks and other financial institutions will have no incentive to lend to one another unless the fed funds rate is higher than the IOER; otherwise, they could realize profit simply by holding funds with the fed. In this way, IOER acts as a floor on the fed funds rate. Currently, the IOER is 0.25%; when the time comes to tighten monetary policy, the Fed is likely to increase the IOER in tandem with the target fed funds rate, so that the effective rate will move in line with the target.
Reverse Repurchase Agreements or Reverse Repos are a tool that has been used by the Federal Reserve for decades, but it was never very prominent in implementing monetary policy. However, given the unprecedented amounts of liquidity in the financial system as a result of the Fed's unconventional policy actions, RRPs have gained widespread popularity as "the new normal" tool to conduct monetary policy. Where in traditional policy used open market operations to influence short term market interest rates, RRPs will do the same thing by offering short term liquidity (typically overnight) to different types of financial institutions in exchange for collateral (US treasuries). RRPs are essentially short-term collateralized loans that function very similarly to that of the traditional Fed Funds market, but it is collateralized and thus will have a lower interest rate charged on the loan. Because RRPs can be given to institutions that cannot earn IOER, this helps support the "floor" the IOER is theorized to create on short term market interest rates. However, this tool can be used for much, much more. A repo is the opposite accounting transaction to a reverse repo fyi.
The Term Deposit Facility is an institution established by the Fed to allow for monetary policy "normalization", which includes the draining of excess reserves from the system over time. Approved by the Federal Reserve Board in April 2010 for all regional Fed banks to adopt, the TDF acts as a supplementary draining tool to Repurchase Agreements/Reverse Repurchase Agreements. It works as follows: the Fed will hold an auction for eligible institutions to be able to deposit their funds in the TDF for a longer period of time (e.g. generally more than 24 hours) in return for a slightly higher interest rate. Only eligible institutions will have the chance to do so. Ultimately, by having institutions deposit funds into the TDF, reserves are removed from the system, thereby aiding in the draining process. This will serve two purposes: to get reserve levels back to historically more "normal" levels, and to reign in the lending of excess reserves. The TDF is still in its testing phases, with auctions held on a periodic basis. It is thought that the TDF will be expanded in the future.
Policy begun by Fed in late 2008 in which interest is paid on reserves held at the Fed that exceed the mandated level of reserves. While it was instituted for several reasons, its primary theoretical use is to act as a "floor" for the fed funds rate. Prior to the Financial Crisis, the Fed could easily control the inter-bank fed funds lending rate by simply adding or subtracting reserves via traditional monetary policy tools (e.g. open market operations, etc.). However, in response to the crisis and the implementation of many unconventional policies (such as quantitative easing), the financial system has an enormous oversupply of reserves, putting relentless downward pressure on the fed funds rate (higher supply = lower "price of money", i.e. interest). This poses a problem for when the time comes for the Fed to end its accommodative monetary policies and begin the process of "tightening", as the large quantity of reserves severely limits its ability to match the effective fed funds rate to the target fed funds rate without a significant withdrawal of reserves. This is where IOER comes it; theoretically, banks and other financial institutions will have no incentive to lend to one another unless the fed funds rate is higher than the IOER; otherwise, they could realize profit simply by holding funds with the fed. In this way, IOER acts as a floor on the fed funds rate. Currently, the IOER is 0.25%; when the time comes to tighten monetary policy, the Fed is likely to increase the IOER in tandem with the target fed funds rate, so that the effective rate will move in line with the target.
Reverse Repurchase Agreements or Reverse Repos are a tool that has been used by the Federal Reserve for decades, but it was never very prominent in implementing monetary policy. However, given the unprecedented amounts of liquidity in the financial system as a result of the Fed's unconventional policy actions, RRPs have gained widespread popularity as "the new normal" tool to conduct monetary policy. Where in traditional policy used open market operations to influence short term market interest rates, RRPs will do the same thing by offering short term liquidity (typically overnight) to different types of financial institutions in exchange for collateral (US treasuries). RRPs are essentially short-term collateralized loans that function very similarly to that of the traditional Fed Funds market, but it is collateralized and thus will have a lower interest rate charged on the loan. Because RRPs can be given to institutions that cannot earn IOER, this helps support the "floor" the IOER is theorized to create on short term market interest rates. However, this tool can be used for much, much more. A repo is the opposite accounting transaction to a reverse repo fyi.
The Term Deposit Facility is an institution established by the Fed to allow for monetary policy "normalization", which includes the draining of excess reserves from the system over time. Approved by the Federal Reserve Board in April 2010 for all regional Fed banks to adopt, the TDF acts as a supplementary draining tool to Repurchase Agreements/Reverse Repurchase Agreements. It works as follows: the Fed will hold an auction for eligible institutions to be able to deposit their funds in the TDF for a longer period of time (e.g. generally more than 24 hours) in return for a slightly higher interest rate. Only eligible institutions will have the chance to do so. Ultimately, by having institutions deposit funds into the TDF, reserves are removed from the system, thereby aiding in the draining process. This will serve two purposes: to get reserve levels back to historically more "normal" levels, and to reign in the lending of excess reserves. The TDF is still in its testing phases, with auctions held on a periodic basis. It is thought that the TDF will be expanded in the future.