ECONOMICS (CBSE/UGC NET)

Detailed explanation-1: -The Federal Reserve Banks pay interest on reserve balances. The Board of Governors has prescribed rules governing the payment of interest by Federal Reserve Banks in Regulation D (Reserve Requirements of Depository Institutions, 12 CFR Part 204).

Detailed explanation-2: -Essentially, paying interest on reserves allows the Fed to place a floor on the federal funds rate, since depository institutions have little incentive to lend in the overnight interbank federal funds market at rates below the interest rate on excess reserves.

Detailed explanation-3: -If the Fed increases the interest rate of reserves, banks will want to keep higher reserves. This will reduce the money multiplier as higher reserves effectively mean a higher reserve ratio. A fall in the money multiplier will reduce the loans given out by banks, reducing the money supply.

Detailed explanation-4: -Key Takeaways. The Federal Funds Rate (FFR) is the average rate that banks pay when borrowing from each other overnight. At its December meeting, the Federal Reserve announced that it would increase its target for the FFR by 25 basis points to a range of 4.50%-4.5%.

Detailed explanation-5: -The Fed sets target interest rates at which banks lend to each other overnight in order to maintain reserve requirements-this is known as the fed funds rate. The Fed also sets the discount rate, the interest rate at which banks can borrow directly from the central bank.