Fed open market operations

let's say we have two banks Bank a and Bank B and you might already know that banks all banks lend out the great majority of the money that they get in as deposits but they keep some of the money as reserves one just in case their depositors come say hey can I have some of my money back and - because the central bank the Federal Reserve says you have to keep a certain amount of your of your deposits in reserve there is a reserve requirement but you could imagine over the course of doing transactions thousands of transactions a day millions maybe maybe Bank B more of its depositors come by and say hey give me some of my deposits back and obviously he's lent out a lot of that money so he starts running low on reserves maybe Bank aid the depositors haven't asked for the money for whatever reason Bank a sitting on a lot of cash so in this situation what you're going to have happen is Bank a is going to lend some reserves is going to lend some cash to Bank B so this is its lending some cash and they'll charge an interest rate for lending that cash maybe it'll be five percent interest and that won't be five percent per day and usually these loans are on a per day basis and then the next day it'll be renegotiated on a per day basis but it's not five percent per day it'll be five percent per year so it'll be much much smaller fraction but usually as I mentioned this lending takes place on a per day basis so we'll say hey this is your cash for just tonight if you need to if you need it for the next night we'll talk again and maybe it'll be another five percent or maybe the interest rate can change again now let's say that the Federal Reserve is sitting over here and for whatever reason wants to stimulate the economy so this is the Fed and they want to stimulate the economy so they start printing some money they say I should do money in green so the Federal Reserve here is start printing they're starting to print some money and they want to do two things they want to inject this money into the banking system which essentially hopefully will find its way into the economy and they also want to lower the interest rate especially the short-term interest rate this overnight borrowing remember this is the annual interest rate but this is an overnight loan Oh over over overnight learns so when I talk about the short-term interest rate I'm talking about the interest rate on loans that are made over very short periods of time so what the Federal Reserve will do is what's called open market operations they will go to the market maybe directly to these banks or some other banks and they will buy Treasuries they will give this money into the market and in exchange they will usually buy Treasury securities sometimes something slightly different but usually very safe securities and maybe it's temporarily buy I'll talk about repurchase agreements in the future and what happens is is that this cash goes in the hands of the people who just sold the Treasury securities and they have to deposit it in banks and so they might deposit it in this Bank over here they might deposit it in this Bank over here or other banks but the net net effect is that there's more cash now in the banking system and if there's more cash in the banking system this this guy right over here needs less this guy needs less cash so it lowers demand it lowers the demand for cash and then this guy has more to give so it raises supply raises the supply because some people maybe just took some of this cash and deposit with them so if it raises the supply of cash and this guy needs it less then the rate to borrow this cash is going to go down so maybe instead of 5% it goes down to 4% so what that would do is it would lower the short term of the yield curve the short end of the yield curve so let me draw a yield curve right over here so this is maturity on this axis maturity and this is yield and let's say that the yield curve before looked like this let's say it looked like this where this right over here is 5% and this is overnight over night this might be the yield on I don't know one year debt this might be the yield on I don't know maybe it's five-year debt whatever I could keep going but by doing this open market operation the Fed was able to do both of its goals it was able to inject cash printed cash into the economy and it's also able to lower the interest rate so it took it from being 5 percent down to 4 four percent so now because of this open market operation the Fed the yield curve might start to look something like that