What's the mechanism through which the federal reserve...?

Question

...and other national financial institutions elsewhere influence lending rates? What's the relationship between the key lending rate and actual bank rates to consumers? Why do economists say the Federal Reserve has less influence than it used to have?

Answer 1

Typically the fed affects lending rates through the overnight lending rate. This is the rate that banks can borrow from national banks and or funds from other banks. This is typically about 100 basis points higher/lower (depends if you are borrowing or saving) than the best rates available to consumers. It changes behaviour in the consumer by either giving a greater or lesser incentive to save or borrow.

Consider the bank increases interest rates, you are now less likely to borrow money for a mortgage, and more likely to save money and gain the higher interest rate.

Economists theorize that the Fed has less influnence for a number of reasons, but I like the capital mobility theory the most. Since capital can go anywhere in the world nowadays (and much easier than in the past), the Feds ability to influence behaviour is relative to the actions of other national banks around the world. Whenever your effect is relative to the actions of others, it has a dampening effect. More importantly it means you may not be able to fully control what occurs.