ETF Trends
ETF Trends

Note: This article is courtesy of

By Mark Germain

You might be wondering about the avian analogy. Doves and hawks once referred to politicians (and others) with anti-war and pro-war leanings, particularly during the Vietnam era. But what does this have to do with monetary policy?

To begin answering the question, we need to define the role of the Federal Reserve System, the central bank of the United States. The job of “the Fed” is to conduct the nation’s monetary policy by influencing money and credit conditions to promote full employment and stable prices.

How? Its main leverage tool is varying the rates regional Fed banks charge its member banks through its “discount window” (known as “the discount rate”). That rate, in turn, impacts the “fed funds rate” — the interest rate that banks charge each other for short-term loans.

Any movement in the fed funds rate eventually trickles down to U.S. households and businesses in the interest rates charged by banks for short and long-term loans such as car loans, mortgages, commercial loans, as well as corporate bonds. The Fed can also try to influence longer-term interest rates by buying or selling U.S. securities (and, during the financial crisis, other debt instruments).

The more bonds the Fed buys (generally by creating new money), the greater the liquidity in the financial system, pushing interest rates down. In the reverse scenario, the Fed sells bonds (i.e. borrows money), pulling funds out of the system, creating competition for private borrowers, thereby forcing interest rates upward.

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