The Federal Reserve runs monetary policy through four tools: open market operations, the discount rate, interest on reserve balances, and reserve requirements. Each one pulls a different lever, but all of them aim at the same thing—the cost of borrowing money across the economy. Congress set the goals the Fed pursues with these instruments in 12 U.S.C. § 225a: maximum employment, stable prices, and moderate long-term interest rates.1Office of the Law Revision Counsel. 12 U.S. Code 225a – Maintenance of Long Run Growth of Monetary and Credit Aggregates The Fed reads “stable prices” as inflation running around 2% per year on the personal consumption expenditures index, a target it reaffirmed in its January 2026 policy statement.2Federal Reserve Board. Federal Reserve Issues FOMC Statement
The Federal Open Market Committee sets the target for the federal funds rate at eight regularly scheduled meetings each year.3Federal Reserve. Meeting Calendars and Information As of January 2026, that target range sits at 3.50% to 3.75%.2Federal Reserve Board. Federal Reserve Issues FOMC Statement The four tools below are how the committee actually holds the market rate inside that band.
Open Market Operations
Open market operations are the Fed’s most frequently used tool. Through the Federal Reserve Bank of New York, the Fed buys and sells government securities—mostly Treasury notes and bonds—in the open market.4eCFR. 12 CFR Part 270 – Open Market Operations of Federal Reserve Banks When the Fed buys, it credits the seller bank’s reserve account with new money, adding reserves to the banking system. When it sells, banks pay for the securities out of their reserves, and the money supply available for lending shrinks.
The Federal Reserve Act, at 12 U.S.C. § 263, hands the FOMC exclusive control over the “time, character, and volume” of these purchases and sales.5Office of the Law Revision Counsel. 12 U.S. Code 263 – Federal Open Market Committee; Creation; Membership No individual Reserve Bank decides on its own to trade; every transaction runs through an FOMC directive. Section 355 gives each Reserve Bank the operational authority to buy and sell Treasury obligations and certain agency securities in the market.6Office of the Law Revision Counsel. 12 USC 355 – Purchase and Sale of Obligations; Open Market Operations
In today’s framework, open market operations are less about pushing the federal funds rate up or down through supply changes and more about keeping enough reserves in the system that the Fed’s administered rates (below) can do the steering.
Interest on Reserve Balances and the ON RRP Rate
This is the tool doing most of the work in the modern Fed framework. The Financial Services Regulatory Relief Act of 2006 gave the Fed authority to pay interest on the money banks keep in their reserve accounts.7Federal Reserve. Financial Services Regulatory Relief Act of 2006 – Section: Monetary Policy Provisions The authority was originally set to begin in 2011, but Congress moved it up to 2008 during the financial crisis.8Federal Reserve History. Interest on Reserves The Interest on Reserve Balances rate, or IORB, currently sits at 3.65%.9Federal Reserve Board. Interest on Reserve Balances
The mechanism is simple. If a bank can earn 3.65% risk-free at the Fed, it has no reason to lend those same reserves to another bank overnight for less. IORB puts a floor under short-term interest rates. When the FOMC wants to tighten policy, it raises IORB, and banks pass that increase through to the rates they charge on mortgages, auto loans, and business credit.
The ON RRP Facility
IORB only reaches banks. Money market funds, government-sponsored enterprises, and certain broker-dealers do not hold reserve accounts at the Fed and cannot earn IORB. Left on their own, those institutions might accept overnight rates below the IORB floor, pulling the federal funds rate down with them. The Overnight Reverse Repurchase Agreement facility, or ON RRP, closes that gap. It lets non-bank institutions effectively lend cash to the Fed overnight against Treasury collateral, earning a guaranteed rate—currently 3.50%.10FEDERAL RESERVE BANK of NEW YORK. Repo and Reverse Repo Agreements
IORB and the ON RRP rate together create a corridor. IORB anchors the top of that corridor for banks, and the ON RRP rate catches everyone else at the bottom. Since this system was adopted, the federal funds rate has stayed reliably inside the FOMC’s chosen band.
The Discount Rate
The discount rate is the interest rate the Fed charges when commercial banks borrow directly from a Reserve Bank at the discount window. Every discount window loan must be backed by collateral—Treasury securities, agency debt, mortgage-backed securities, and certain other assets—pledged to the satisfaction of the lending Reserve Bank.11Board of Governors of the Federal Reserve System. Policy Tools – Discount Window The window comes in three programs:
- Primary credit, available to banks in generally sound financial condition with no restrictions on use. Its rate is currently 3.75%, set at the top of the federal funds target range.12Federal Reserve. Discount Window Lending
- Secondary credit, for banks that do not qualify for primary credit, priced higher and typically with steeper collateral haircuts.
- Seasonal credit, designed for smaller banks with seasonal deposit and loan swings such as agricultural lenders, at a floating market-based rate; institutions with deposits above $500 million generally do not qualify.
Because primary credit is priced at the top of the federal funds target range, it acts as a ceiling on short-term borrowing costs. No bank pays 3.75% at the window when it can borrow from another bank at a lower rate. That is deliberate: the Fed wants the discount window used as a safety valve, not a first stop.
Reserve Requirements
Reserve requirements once did much of the work these other tools now do. Under 12 U.S.C. § 461, the Fed can require banks to hold a percentage of their deposits either as vault cash or on deposit at a Federal Reserve Bank, anywhere from zero to 14% on transaction account balances above a threshold.13Office of the Law Revision Counsel. 12 USC 461 – Reserve Requirements A higher ratio meant banks could lend less of each dollar deposited; a lower ratio freed up more.
In March 2020, the Fed cut the reserve requirement to zero across all deposit categories, and it has stayed there. Every tier in the current Regulation D table—transaction accounts, nonpersonal time deposits, Eurocurrency liabilities—shows a 0% requirement.14eCFR. 12 CFR Part 204 – Reserve Requirements of Depository Institutions (Regulation D) Banks still hold large reserve balances, but voluntarily, because IORB gives them a reason to. The statute has not been repealed, so the Fed retains the authority to reimpose reserve requirements if conditions call for it.
Quantitative Easing and Quantitative Tightening
When the federal funds rate is already near zero and the economy still needs support, the Fed uses quantitative easing: large-scale purchases of longer-term Treasury securities and mortgage-backed securities intended to push down long-term interest rates directly.15Board of Governors of the Federal Reserve System. Quantitative Easing and the “New Normal” in Monetary Policy It is open market operations conducted at a much larger scale and focused on the long end of the yield curve rather than overnight rates. The Fed used QE after the 2008 financial crisis and again during the COVID-19 pandemic, expanding its balance sheet to roughly $9 trillion by mid-2022.
Quantitative tightening runs in reverse. Starting in June 2022, the Fed let Treasury and mortgage-backed securities roll off its balance sheet as they matured, without replacing them. That process concluded on December 1, 2025, with the balance sheet settling at roughly $6.5 trillion, or about 21% of GDP.16Board of Governors of the Federal Reserve System. The Central Bank Balance-Sheet Trilemma QE and QT are not separate tools so much as the same open market authority used at a different scale when ordinary rate moves have hit their limits.
How the Four Tools Work Together
The tools look independent on paper. In practice, they form a single system for keeping the federal funds rate inside the FOMC’s target range:
- IORB at 3.65% is the primary anchor. Banks will not lend reserves for less than they can earn risk-free at the Fed, so this rate pulls the federal funds rate toward the upper portion of the range.
- The ON RRP rate at 3.50% is the sub-floor for non-banks. Money market funds and similar players park cash there rather than accept a lower rate elsewhere, preventing the federal funds rate from drifting below the bottom of the range.
- The primary credit rate at 3.75% is the ceiling. No bank pays more than that in the interbank market when the discount window is available.
- Open market operations keep the level of reserves large enough that the administered rates above actually bind. Without ample reserves, the floor-and-ceiling mechanism breaks down.
Reserve requirements, currently at zero, play no active role in this arrangement. What makes the system function is that banks voluntarily hold large reserve balances because IORB pays them to. The shift from a scarce-reserves model, where the reserve requirement was the binding constraint, to an ample-reserves model, where administered interest rates do the steering, is the defining change in how the Fed has operated over the past fifteen years. Every rate decision the FOMC announces flows through this architecture before it reaches the rate on a mortgage or a business loan.