Floor System Fed

Before 2008 the interest rate policy system is a so called corridor system where the discount rate served as the corridor ceiling and the zero lower bound zlb was the floor. Today s post will explain how reality has differed from theory for conducting policy and what the fed s solution has been. In this system the demand curve of the bank reserve market is downward sloping with respect to the interbank interest rate.

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To affect the federal funds rate in a floor system the fed cannot rely on open market operations.

Floor system fed.

Hence the supply of federal funds has no effect on the ffr so long as the fed is operating in a floor system. Yesterday s post explained that the federal reserve has moved from a channel system to a floor system regarding the conduct of monetary policy. Over the long term however the fed should find another approach to policy implementation. Fed s pre 2008 corridor system.

If it increases the rate it pays on reserves the federal funds rate will. A more detailed discussion of these efficiency concerns and other differences between corridor type and floor type systems can be found in two federal reserve publications divorcing money from monetary policy and understanding monetary policy implementation leaky ceilings and soggy floors. The fed s operating system changed from a corridor system to a floor system in 2008 i e from a system where money in the form of reserves mattered for monetary policy to one in which money. The floor system has worked well so far in re normalizing the fed s policies after the extended period of exceptionally low interest rates made necessary by the financial crisis.

Instead it must adjust the interest rate it pays on reserves. Today s post is the second in a two part series on how the federal reserve influences interest rates.

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