Floor System Fed

Today s post is the second in a two part series on how the federal reserve influences interest rates.

Floor system fed.

In this system the demand curve of the bank reserve market is downward sloping with respect to the interbank interest rate. Fed s pre 2008 corridor system. Instead it must adjust the interest rate it pays on reserves. Yesterday s post explained that the federal reserve has moved from a channel system to a floor system regarding the conduct of monetary policy.

Hence the supply of federal funds has no effect on the ffr so long as the fed is operating in a floor system. Over the long term however the fed should find another approach to policy implementation. 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. 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.

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 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.