What Is a Fed Pass?
A Fed pass is a colloquial term for an action taken by the U.S. Federal Reserve to increase the availability of credit by creating additional reserves in the banking system. The Fed “passes” more money to the banks in the hope that they will lend it out.
Most commonly, the supply of bank reserves is increased through open market operations as the Fed purchases Treasury debt from primary dealers, with the goal of allowing lenders to originate more mortgages and other loans at lower interest rates.
- A Fed pass is when the Fed sends newly-created money directly to the commercial banking system.
- The Fed normally buys Treasury debt through its open market operations and passes new money to banks to pay for the purchases in the form of reserve credits on their Fed accounts.
- A Fed pass is an example of expansionary monetary policy.
Understanding a Fed Pass
A Fed pass refers to expansionary monetary policy conducted 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 effect on the economy. When interest rates are high or credit conditions are tight, either because of a real economic shock, the collapse of asset price bubbles, or pessimistic expectations about the economy, the Fed often intervenes to ease credit and increase lending and borrowing in the economy.
The Fed cannot 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. The goal is to make up for whatever negative factors are dragging on the economy by inflating the supply of bank credit.
To inject more money into the banking system, the Fed buys U.S. Treasury bonds on the secondary market from a list of approved banks and other institutional holders known as primary dealers. These are sometimes referred to as “open market operations" (OMO). The Fed pays for those bonds by creating new credits to the Federal Reserve accounts of the sellers, which is the actual “pass.” The Fed passes the newly created money to the banks. The banks, in turn, can hold that cash as excess reserves, use it to buy other assets, or generate more loans.
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. The recipients of the new money could always choose to buy other assets, such as equity stocks, or to hold the new money as excess reserves to maintain their own liquidity against their liabilities.
If they do lend out the money, then it results in a multiplier effect across the economy because of the nature of fractional reserve banking. Banks will then 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 inflationary effects as the money trickles down from the banks to consumers and businesses. At that point, the Fed could reverse its pass and instead begin selling bonds, which will tighten credit and hopefully slow down economic growth.