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Interest on Reserves (IOR) and Overnight Reverse Repurchase (ON-RRP) Rate Consider the following conversation between Teresa, a teaching assistant, and Neha and Sam, students in her Economics class. TERESA: Nowadays, the Federal Reserve can influence household spending, business investment, production, employment, and inflation in the United States. Could someone explain how the Fed manages the interest rate levels? NEHA: The Fed does so by   changing   . SAM: In order to do this, the Fed changes   and   . TERESA: Suppose the current federal funds rate is 1.50% and the Fed wants to raise it. What should the Fed do? NEHA: The Fed needs to set the IOR rate   the current federal funds rate, say, to   . TERESA: Please identify which of the following accurately explains the effect of this strategy by the Fed? Banks will borrow reserves in the federal funds market at 1.50% and place those reserves on deposit with the Fed to earn 2.00%. Banks will remove the reserves they hold with the Fed that earn 1.00% and lend out those reserves in the federal funds market to earn 1.50%. SAM: As a result, reserves in the federal funds market   , pushing   the federal funds rate. TERESA: What is the main objective of the ON-RRP rate? NEHA: The primary objective of the ON-RRP rate is to priovide a   for short term interest rates, ensuring that they do not   the target set by the Fed.

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