Interest rates indirectly affects the operations in the open market (OMOs), buying and selling government securities on the public financial markets.
OMOs instruments of monetary policy, which will allow the Central Bank to control the money supply in the economy. Under the policy tight, the Central Bank sells securities on the open market, which reduces the amount of money in circulation. Expansionary monetary policy entails the acquisition of securities and increase the money supply. Changes in the money supply affect the rates at which banks lend to each other, a reflection of the basic law of supply and demand.
In the US, the Federal funds rate is the interest rate at which banks borrow reserves from each other overnight to meet their reserve requirements. This is the interest rate at which the Federal reserve system of indicators in conducting OMOs. Short-term interest rates offered by the banks based on the rate on Federal funds, the fed can indirectly affect the interest rates faced by consumers and businesses for the sale and purchase of securities.
In 1979, the fed under Chairman Paul Volcker began to use OMOs as a tool. To fight inflation, the fed started the sale of securities to reduce the money supply. The reserves fell by enough to push the Federal funds rate to 20%. 1981 and in 1982 some of the highest interest rates in modern history, with the average 30-year fixed mortgage rates are rising above 18%.
On the contrary, the fed purchased more than $ 1 trillion in securities in response to the recession of 2008. This expansionist policy, called quantitative easing, increasing the money supply and drove down interest rates. Low interest rates helped to stimulate business investments and demand for housing.