Economists had predicted that the federal funds rate for market clearing would never drop to or below the interest rate that the Federal department pays on reserves, reasoning that banks could then earn at least the same rate of interest by holding reserves with the Federal department instead of making federal funds loans. In fact, government-supported and foreign financial institutions, which do not hold reserves with the Federal department but can borrow or lend on the federal funds market, have made loans to U.S. banks at federal funds rates market clearing below the Fed's interest rate on reserves.
Tasks:
Discuss how banks can profit from borrowing at a federal funds rate lower than the interest rate that the Fed pays on reserves.