Inflation Rate & Money Market

The monthly index in January 2009(1997=100) was 109.0996 and monthly index for January, 2010 was 101.8388. This indicates that the dollar weakened by 6.65% on a trade weighted basis during the 12 month period. The index came up little in February, 2010 to 103.8036. But with the recent increase in oil price from $74 to above $80 indicates a further pressure on US Dollar and the trade-weighted exchange rate.

3) The FED uses four major tools for its monetary policy.

1) Open-Market Operations

2) Discount Rate

3) Reserve Requirements

4) Interest on Bank Reserves (Oct. 2008)

The FED uses above tools when increases the Federal Rates by 25 basis points. With this rate tightening, Fed sells government securities to a firm that deals in them. The Federal Fund rate is what banks charge one another for overnight use of excess reserves. Banks avoid dipping below their required percentage of money on reserve by borrowing from one another. The Fed uses the federal funds rate to control the supply of available funds. When Fed Funds rate goes up by 25 basis points, banks will curtail borrowing among each other and reduce the amount of new loans. The primary rate stays 50 basis points above the Federal Funds rate, so it will be 75 basis points. The Discount Rate is the interest rate the Fed offers to member banks and thrifts who need to borrow money from the central reserve bank to avoid having their reserves dip below the required minimum. The discount rate is not directly affected by the Federal Funds rate but stays 1% above the Federal Funds rate.