What is FED Pass
A Fed pass is an action taken by the U.S. Federal Reserve to increase the availability of credit by moving additional reserves into the banking system. The supply of loans is increased as more funds are injected into major banks, typically allowing lenders to originate more mortgages and other loans at lower interest rates.
BREAKING DOWN FED Pass
A Fed pass is a prime tool used by the Federal Reserve to influence the economy. It could be taken to combat economic difficulties, such as a credit crunch. But like all Fed actions, it has only an indirect affect on the economy. When money is tight, either because interest rates are high, banks are wary of lending, or consumers and businesses are saving instead of spending and borrowing, the Fed often intervenes to jumpstart the economy. The Fed can’t force people to buy more stuff, or even force banks to loan more money. But by injecting more cash into the banking system it hopes that banks will be encouraged to lend more, and at lower interest rates that are more appealing to consumers and businesses.
To inject more money into the banking system, the Fed buys back U.S. Treasury bonds from banks and other institutional holders. These are sometimes referred to as “open market operations” (OMO). The Fed pays for those bonds by depositing cash in the banks, which is the actual “pass.” The banks, in turn, can use that cash to generate more loans, up to the reserve requirement mandated by the Fed. If the reserve requirement is 10 percent, then the bank must hold in reserve at least $1 out of every $10 it holds, to guard against bank runs.
The Multiplier Effect of a Fed Pass
There is no guarantee that a Fed pass will stimulate lending or borrowing, which are also influenced by external economic factors and consumer sentiment. But usually a monetary expansion by the Fed results in a multiplier effect across the economy. Banks will issue more loans to businesses and consumers, who will in turn spend the money on goods and services; the seller of those goods and services will then re-deposit the money in banks, which then re-loan the money.
As the economy heats up from all this activity, eventually the Fed could become nervous about excess growth, which can lead to inflation. At that point the Fed could reverse its pass and instead begin selling bonds, which will tighten credit and hopefully slow down economic growth.