During normal times
in the economy, the Fed tries to control the
amount of economic activity that's occurring by targeting
the federal funds rate. The fed funds rate. And this is the
rate that you always hear talked about on the news. And it's essentially
a target rate that the Fed wants to see
banks lending money-- lending cash to each other--
on an overnight basis. And we saw already
in the last video, if the Fed does not like the
rate that they're borrowing to each other, and if even
announcing the federal funds rate does not cause
the banks to say, hey, the Fed's going to intervene
if we don't lend to each other at that rate, the Fed
can actually intervene. It can go out there, perform
open market operations, and buy, usually
treasury securities, out from just the
general market. And what that does is it
increases the amount of cash that is in circulation, which
decreases the demand for cash, increases the supply, and it
should lower the interest rate. And the Fed usually cares about
getting that interest rate within a certain zone,
around a certain target. And the treasuries that
the Fed normally buys are short-term treasuries. And this is just because
this is less risky, and sometimes they'll even make
it on a temporary agreement. They'll say, look, we'll
buy it from you now, only if you agree to purchase
it at some future date at a certain price. And that's called a
repurchase agreement. I'll do a whole
other video on that. But the whole point of
open market operations is to set this overnight
borrowing rate. But they usually deal with
the short-term treasury debt because it's safer. It exposes the Fed to
less interest rate risk. But you can imagine what
happens if the Fed keeps lowering interest rates in
order to prime the pump, in order to try to
stimulate the economy. So it keeps lowering the federal
funds rate from 4%, down to 3%, down to 2%, maybe going all
the way down eventually to 0%. And the whole time, it's been
doing that by printing money and buying short-term
US securities. And maybe at this point, the
yield curve looks like that. But maybe that's not enough. Maybe the economy's
still tanking. Maybe people aren't getting
mortgage loans still. So now, the Fed can no longer
do its traditional open market operations. And it will no longer be focused
on just the federal funds rate, because really,
it can't go any lower. It already hit zero. Short-term overnight borrowing
between banks is already zero. But if the Fed wants
to inject more cash, it can now buy different
types of securities. It can buy treasury
securities that are-- so instead of short term
treasury securities, maybe it could be longer
term treasury securities. So maybe stuff that's one
year out, five years out, 10 years out. And the point here
would be two-fold. One, to inject cash
into the system, to print cash and put
it out there so it's there for people to invest
and for the banking system to operate. But it might be to explicitly
control the yield curve further out so that borrowing
costs for longer debt goes down, so that the
yield curve looks something like that. Because if it's buying
longer maturity treasuries that will lower the yield. Or they might even start to buy
things that aren't treasuries. Maybe they'll buy
mortgage-backed securities. So it makes the mortgage
market a little bit looser, a little bit more liquid. And this non-traditional
type of intervention, where the Fed is no longer
concerned about a target rate, because the target rate
is already at zero. Where the Fed is not
purchasing short-term debt, but is starting to
buy longer term debt, things further down
the yield curve. And maybe things that
aren't treasury securities to begin with. Maybe they're starting
to buy corporate debt. Maybe they're starting to buy
mortgage-backed securities. This is called
quantitative easing. And there's two
elements to it that make it different from
traditional Fed open market operations. They are now no longer concerned
about the Fed fund rate, because it's already at zero. The other thing is, is
that they're buying things maybe further down
the yield curve. So they're trying to control
the yield curve itself. And they're maybe buying
less traditional securities, with the goal of maybe making
those markets a little bit more operational.