Tags: Federal Reserve | policy | bank | rates

Fed Actions Show Tightening Started Despite Their Speeches

By    |   Friday, 29 May 2015 08:13 AM

At least one indicator shows the Federal Reserve has already started tightening. Declining excess reserves confirm the Fed has the ability to change monetary policy without raising interest rates.

Banks are required to hold a minimum amount of reserves to ensure they have cash available to meet day-to-day operating needs. Large banks must hold 10 percent of deposits as a minimum.

Historically, banks have maintained reserve levels as close to the minimum as possible. Excess reserves were lent to individuals and business or invested to increase bank profits and to fuel economic growth.

Since the financial crisis, the Fed has encouraged banks to hold excess reserves by paying interest on these reserves. This has resulted in the financial sector benefitting from Fed payments, while banks withheld money from the economy.

In February, Fed data showed the amount of free reserves declined. In the past few years, the pace of gains in the stock market has slowed whenever excess reserves declined. The S&P 500 index is essentially unchanged since February, confirming that the Fed has withdrawn a source of growth from the stock market.

Traditionally, the Fed has raised interest rates to signal a policy shift. Since quantitative easing broke the link between interest rates and monetary policy, the Fed will be using nontraditional tools to tighten the money supply. To profit in this new environment, investors need to watch what the Fed does rather than relying on what Fed officials say.

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MichaelCarr
At least one indicator shows the Federal Reserve has already started tightening. Declining excess reserves confirm the Fed has the ability to change monetary policy without raising interest rates.
Federal Reserve, policy, bank, rates
241
2015-13-29
Friday, 29 May 2015 08:13 AM
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