Ample Reserves and Administered Rates

For decades the Fed hit its target rate by shrinking or growing the reserve supply: buy bonds, add reserves, push the rate down; sell bonds, drain reserves, push it up. That only works when reserves are scarce, so small changes in supply swing the rate along a steep demand curve. After the 2008 crisis the Fed flooded the system with reserves through quantitative easing, and reserves stayed abundant ever since. On a graph of the reserve market, ample reserves sit on the flat part of the demand curve, far to the right of where banks would ever need to borrow overnight. Adding still more reserves just slides along that flat stretch and barely touches the rate.

So the Fed switched tools. It now pays interest on reserves, an administered rate it sets directly, and that payment becomes a floor. No bank will lend its spare reserves to another bank overnight for less than it could earn safely by just leaving them parked at the central bank. Every bank refuses to lend below that floor, so the federal funds rate settles right near it, moving only when the Fed changes the administered rate, not when it changes the quantity of reserves.

This sits next to the money market model from earlier in the unit: same federal funds rate, but a different control knob. Scarce reserves mean quantity control along a sloped demand curve; ample reserves mean price control through an administered floor. The real interest rate and loanable funds market downstream still respond to whatever nominal rate comes out of this process.