Reply To: Full Employment, Cycles, Etc


First, the Fed only influences interest rates. It only determines the discount rate. And it’s influence is strongest on the federal funds rate. When the Fed buys securities from banks it pays by crediting the banks’ checking accounts which they have at the Fed. Since the balances in these accounts are bank reserves, the Fed increases bank reserves with expansionary monetary policy. The federal funds rate is the interest rate for banks when they borrow reserves over-night from other banks. The effect expansionary monetary policy has on other interest rates depends on what banks do with the greater reserves.

Here is the spread between 10 year T-bonds and 3 month T-bills:

There are tendencies, but not a uniform effect on interest rates across the yield curve from a given expansionary policy of the Fed.

Second, entrepreneurs adapt as best they can to government intervention. They economize as fully as possible given the interference of Fed policy. Of course, entrepreneurs would economize more fully if there was no Fed, but they do the best they can in the face of the additional difficulties the Fed generates.

The Taylor rule proposes a feedback mechanism which requires assessing the rate of price inflation against an ideal rate and the rate of growth against an ideal rate in order to set the target fed funds rate.