Definition of Fed Pass

What is a Fed Pass?

A Fed pass is a colloquial term for an action taken by the United States Federal Reserve to increase the availability of credit by creating additional reserves in the banking system. The Fed “passes” more money to the banks in the hope that they will lend it.

Typically, the supply of bank reserves increases through open market operations as the Fed purchases Treasury debt from primary intermediaries, with the aim of allowing lenders to originate more mortgages and other loans at lower interest rates. low.

Key takeaways

  • A Fed pass is when the Fed sends newly created money directly to the commercial banking system.
  • The Fed typically buys Treasury debt through its open market operations and passes new money to banks to pay for purchases in the form of reserve credits on its Fed accounts.
  • A pass from the Fed is an example of expansionary monetary policy.

Understanding Fed Pass

A pass from the Fed refers to the expansionary monetary policy carried out by the Federal Reserve to influence the economy. It could be taken to combat economic difficulties, such as a credit crisis. But like all Fed actions, it only has an indirect effect on the economy. When interest rates are high or credit conditions are tight, whether due to a real economic shock, the collapse of asset price bubbles, or pessimistic expectations about the economy, the Fed often steps in to facilitate credit. and increasing borrowing and borrowing in the economy.

The Fed cannot force people to buy more things, or even force banks to lend more money. But by injecting more cash into the banking system, he hopes that banks will be motivated to lend more, and to lower interest rates that are more attractive to consumers and businesses. The objective is to offset the negative factors that are dragging the economy by inflating the supply of bank credit.

To pump more money into the banking system, the Fed buys US Treasuries on the secondary market from a list of approved banks and other institutional holders known as primary traders. They are sometimes called “open market operations” (OMO). The Fed pays off those bonds by creating new credits in the sellers’ Federal Reserve accounts, which is the actual “pass.” The Fed passes the newly created money to the banks. Banks, in turn, can hold that cash as excess reserves, use it to buy other assets, or generate more loans.

The multiplier effect of a Fed Pass

There is no guarantee that a Fed pass will stimulate lending, which is also influenced by external economic factors and consumer confidence. The recipients of the new money could always choose to buy other assets, such as stocks, or to keep the new money as excess reserves to maintain their own liquidity against their liabilities.

If they lend the money, there is a multiplier effect throughout the economy due to the nature of fractional reserve banking. Banks will then make more loans to businesses and consumers, who, in turn, will spend the money on goods and services; the seller of those goods and services will re-deposit the money in the banks, which will then lend the money again.

As the economy heats up from all this activity, eventually the Fed could get nervous about inflationary effects as money flows from banks to consumers and businesses. At that point, the Fed could reverse its approval and instead start selling bonds, restricting credit and hopefully slowing economic growth.

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Mark Holland

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