The Federal Reserve’s Three Buckets

Explaining the Federal Reserve’s monetary policy used to be simple. The Fed raises and lowers the discount rate that it charges banks for loans. By buying and selling government securities, it influences the money available to banks and thereby nudges interest rates and the money supply up or down. And rarely, it changes financial institutions’ reserve requirements.

Now, there is much more.

But we can make it simple by using three buckets.

Three Buckets: Pandemic Monetary Policy

Bucket #1: Lender of Last Resort

Through lending programs, the Federal Reserve will support households, businesses, and financial institutions. They want to help the companies that raise money through bond-like securities called commercial paper by purchasing them. They are providing loans to banks so that they can loan money to you and me and also buy assets that help money market funds deal with withdrawals.

The Fed’s lending initiatives involve many billions of dollars. But the key here is the money’s destination. Their goal is to boost economic activity by making money available to the businesses and individuals that will use it productively.

The Fed was able to make it cheaper for businesses to borrow money through commercial paper:

Bucket #2: Fiscal Partner

We know that the Congress and the President are responsible for the spending, taxes, and borrowing that we call fiscal policy while the Federal Reserve independently implements monetary policy. Now though the Fed is complementing the CARES Act stimulus programs for businesses, individuals, and state and local governments. At the same time that it has created a lending program for mid-size and small businesses, it is also buying the notes that state and local governments use to borrow money.

Because higher yields make borrowing much more expensive, the Fed entered municipal markets to push them downward:

Bucket #3: Investor of Last Resort

In this bucket, the Fed is again helping businesses borrow money. However, as a lender of last resort in the first bucket, they focused on top-rated debt with minimal risk. This third bucket will contain riskier loans. Their reasoning though is not to support the holders of low quality corporate debt. Instead they say they want to maintain the markets in which those loans trade.

So really, the Fed is just a lender, a fiscal partner, and an investor.

Our Bottom Line: The Fed’s  Policy Goals

Before the coronavirus pandemic, we were close to a Goldilocks economy. Growth was slightly less than optimal at a 2 or 3 percent rate. A 3.5 percent unemployment rate for December 2019 was a record low. And, close to a 2 percent inflation rate was ideal for stable prices.

But then, when the March 2020 pandemic lockdowns began and the numbers went haywire, the Federal Reserve recognized the need for historically proactive and creative policies.

Still though, as a lender, a fiscal partner, and an investor, the Federal Reserve always has three basic goals. They want to…

• Optimize economic growth
• Minimize unemployment
• Preserve stable prices

My sources and more: Thanks to the Planet Money Indicator podcast for introducing me to the Fed’s three buckets and to BloombergLaw  for the detail. Then for a firsthand look the Fed describes its programs here and here and here. And finally, if you want more Fed links, they are in the Bloomberg Law article.

Our featured image is from pngimg.com.