Home Loans and the Rise and Decline of Interest Rate

According to the video, interest rates have been near zero since the monetary crisis and that’s made it cheaper for nearly everyone to borrow. As the economy ameliorates, the federal government wants to increase interest rates, and to keep up with the new economic era, the federal government has employed a new toolkit that is a mix of market forces and monetary management coming togetheri The federal government had noticed that some of the tools that were used in prior decades to maintain interest rates didn’t work as they once did, which led them to develop a set of new guidelines to push up rates and to keep them on a desired range If one thinks of interest rates as a skyscraper, with the higher end representing a number like 025%, while the lower end representing a number like 0%, the higher level is where the fed will keep bank reserves.

If big banks, like Citibank and Chase, put some of their money in this higher level, they will earn 025% interest through the fed, and this interest rate is called the IOER, the interest on excess reserves.

Setting the interest on excess reserves rate is the federal government’s primary new tool.

However, unlike big banks, home loans cannot invest their money in this higher level, and make their money by loaning to big banks. Big banks are the ones that in an advantageous position because they can borrow money from home loans and then invest into where the fed keeps bank reserves, and it could ultimately receive the IOER back from the fed which it can use to pay back the home loans and keep the rest as profit The loans that home loans make to big banks is a market that determines the fed’s benchmark, known as the Fed Funds Rate As the Fed Funds Rate moves up and down between percentages, so does the cost of borrowing Another tool of the fed is reverse repo program which gives home loans another place for it to put its money and earn interest at a rate set by the fed If the fed sets this rate at a rate that home loan is loaning to big banks, then home loan will increase the rate that it loans to big banks, which is how the federal government sets the floor.

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