Explain how the Federal Reserve limits deviations of the market's Federal Funds rate?Explain how the Federal Reserve limits deviations of the markets federal Funds rate from its target through use...
Explain how the Federal Reserve limits deviations of the markets federal Funds rate from its target through use of the “corridor system.
The "corridor" or "channel" system, which the Fed did not use in the past, sets boundaries on the federal funds rate. The ceiling, or upper limit, of the "corridor" for deviations in the federal funds rate is the discount rate. The floor, or bottom limit, of the deviation is the interest rate on excess reserves. This is how the corridor system limits deviations (i.e., changes in) the federal funds rate: it cannot go higher than the discount rate nor lower than the excess reserve rate.
As #2 states, this is all about manipulating the market to try and produce the interest rates that it feels will be most beneficial to the country. It is then able to use what resources are at its disposal in order to ensure that it is able to work towards achieving those rates through the buying and selling of various government securities.
This is an example of market-based manipulation rather than mandated regulations. By using the system as it is set up, the Fed can influence interest rates without creating new laws or rules that cannot be fully enforced; however, it also allows the Fed to have a greater influence on the market than other parties, since the Fed is so large.
Basically, it does this by setting a goal for what sort of interest rates it wants. Then it uses open market operations (buying and selling government securities) to adjust the rate as needed without actually mandating a rate change. This way it can keep rates relatively stable.