Final answer:
The Federal Reserve directly changes the federal funds rate during open market operations (OMOs).
Step-by-step explanation:
The Federal Reserve directly impacts the federal funds rate through open market operations (OMOs), a key tool in its monetary policy toolkit. Open market operations involve the buying and selling of U.S. Treasury bonds by the central bank in the open market. The primary objective is to influence the quantity of bank reserves and subsequently regulate the level of interest rates.
The specific interest rate targeted in open market operations is the federal funds rate. This rate represents the interest at which commercial banks lend reserves to one another overnight. By adjusting the supply of reserve balances through the buying or selling of Treasury bonds, the Federal Reserve can influence the federal funds rate.
When the Federal Reserve wants to decrease the federal funds rate, it engages in open market purchases, buying Treasury bonds from banks. This injects money into the banking system, increasing the supply of reserves and putting downward pressure on the federal funds rate. Conversely, if the Fed aims to raise the federal funds rate, it conducts open market sales, selling Treasury bonds to banks. This reduces the supply of reserves, causing the federal funds rate to rise.
The federal funds rate is a key benchmark influencing borrowing and lending rates throughout the broader economy. By using open market operations to target this rate, the Federal Reserve effectively steers monetary policy, impacting interest rates and managing the overall money supply to achieve its dual mandate of price stability and maximum sustainable employment.