Lesson 4 of 7
The rate a central bank sets
Which rate a policy rate actually is, over what horizon, and how far along the curve it reaches. Described from the central bank's own published account.
By Javier Sanz
Founder of ValueScreener. Built Ninety Nine, a securities services provider, and sold it to a tier-one global bank; ran operations and internationalization at Alpaca, the brokerage API.
Who writes thisEditorial processLinkedIn (opens in a new tab)X (opens in a new tab)
In one minute
- The policy rate in the United States is a target range for one overnight rate: what depository institutions charge each other to lend reserve balances overnight.
- It is a range set by a committee, held there by operations, and it applies to lending that matures tomorrow morning.
- Every rate that matters for a long project is a different number, set in a different market, and only loosely tied to the overnight one.
The previous three lessons treated "the rate" as a single thing. This lesson says exactly which rate a central bank actually sets, because the answer constrains what the rest of the track is allowed to claim.
Published Treasury yields on one date
- 1 month3.93 percent
- 3 months4.07 percent
- 2 years4.63 percent
- 10 years4.96 percent
- 30 years5.35 percent
Which rate it is
The Federal Reserve's own description is precise. The federal funds rate is the interest rate at which depository institutions lend reserve balances to other depository institutions overnight, and the Federal Open Market Committee establishes a target range for it.
Two things follow. The rate is a price in a market between banks, not a rate any company or household borrows at. And it is overnight, so the contract it prices is undone by the next business day.
How it is held there
Not by decree. The Federal Reserve describes using open market operations, and since the normalisation that began in December 2015 also overnight reverse repurchase agreements, as a supplementary tool to help keep the federal funds rate in the target range. Since 2021 it has run standing repurchase operations which it describes as limiting upward pressure and helping provide a ceiling on rates.
That is an operating framework. This lesson describes it and evaluates none of it.
How far it reaches
Look again at the figure. The shortest maturities sit close together. By two years the curve has moved, by ten years it has moved further, and the thirty year point is more than a point above the one month point on the same day.
Nobody sets those. They are what lenders and borrowers agree, for money committed over years, against their own view of inflation, growth and risk. A change in the overnight target is one input to that judgement and not the whole of it.
Why this matters for the theory
Because the projects this track is about are long. A machine tool, a mine, a shipyard: the relevant discount rate is out at the right-hand end of that figure, not the left.
So a careful statement of the mechanism in the next courses cannot be that a committee sets the rate at which long projects are discounted. It has to be that credit conditions change, that the terms on which the future is bought move with them, and that the overnight rate is one visible part of a larger change. The looser the connection between the two ends of the curve, the more work the rest of the theory has to do.
Check yourself
What exactly is the US policy rate?
- The rate banks charge their customers
- A target range for the overnight rate at which depository institutions lend reserve balances to each other
- The ten-year Treasury yield
Show the answer
Answer: B.
That is the Federal Reserve's own published definition, and the Federal Open Market Committee sets the target range for it.Which tools does the Federal Reserve describe using to keep the rate in the range?
- Reserve requirements alone
- Open market operations, overnight reverse repurchase agreements and standing repurchase operations
- Direct instructions to commercial banks
Show the answer
Answer: B.
Its published account names open market operations, overnight reverse repos as a supplementary tool from December 2015, and standing repo operations since 2021.Why does the reach of the policy rate matter for this track?
- Because short rates are more volatile
- Because the projects the theory is about are long, so the relevant rate is at the far end of the curve, which nobody sets
- Because the curve is always upward sloping
Show the answer
Answer: B.
The mechanism has to run through credit conditions generally rather than through a committee setting the discount rate on a four-year plant.Sources
- Board of Governors of the Federal Reserve System, 'Open Market Operations', published on federalreserve.gov, for the definition of the federal funds rate, the Federal Open Market Committee's target range, the use of overnight reverse repurchase agreements as a supplementary tool from December 2015, and standing repurchase operations since 2021.
- US Department of the Treasury, daily Treasury par yield curve rates, series for 11 September 2026, for the maturities plotted in the figure.
What this leaves out
- This is a heterodox tradition. The mainstream account of the same phenomenon differs, and nothing here is a forecast or a view on any security.
- The yields plotted are published rates for one day, 11 September 2026. They are a snapshot and not a claim about any trend, and nothing here is a view about where any rate goes next.
- The example of the four-year plant is illustrative and describes no company.
- This lesson describes an operating framework from the central bank's own published account. It does not assess it, and no position on how monetary policy should be conducted is taken anywhere in this track.