For students, what a textbook says is ground truth. But for nearly 15 years, leading introductory economics textbooks gave students an outdated or incomplete explanation of how the Federal Reserve conducts monetary policy. Only now are the textbooks catching up with reality, and some still haven’t fully embraced the new world.
Similar outdated material appeared in part of the curriculum and exams for the College Board’s Advanced Placement courses. They have been updated, but with a long lag. And the Council for Economic Education, a nonprofit, is aiming to publish updated standards for what high school economics students should know in 2025. Those standards are the basis of many states’ economics curriculums.
I’m not sure how consequential this lag in reflecting reality is. People who were schooled in outdated information would have been set straight soon enough by a professor in an upper-level course, a boss at a bank or an editor at a newspaper. Still, it’s disappointing — though maybe not surprising — that it has taken so long for the notoriously slow-moving world of education to catch up.
To explain where the textbooks lagged, I need to do a quick run through the recent changes in monetary policy.
To steer the economy, the Federal Reserve sets a target for the federal funds rate, which is the rate that banks charge one another for overnight loans. Until 2008, the Fed influenced the federal funds rate by adding or subtracting reserves from the banking system. It did so through the buying and selling of bonds, which is known as open market operations. When a bank buys Treasury bonds from the Fed, it pays with some of its reserves, which are held in what’s basically a checking account at the Fed. Before 2008, when the Fed soaked up reserves from the banks by selling bonds to them, banks that were short on reserves would have to go into the federal funds market and borrow them, driving up the interest rate on those interbank loans. That uptick would cascade through to higher interest rates across the economy, cooling growth and inflation.
The global financial crisis of 2007-9 changed all that. The Fed heavily bought bonds from banks to drive down long-term interest rates, paying as usual by crediting their accounts with more reserves. The banks became so flush with reserves that no banks needed to borrow them, and the federal funds rate fell to effectively zero. To put a floor under the federal funds rate, the Fed began paying interest on banks’ reserves, reasoning correctly that no bank would lend to another bank at a rate lower than what it could earn on reserves kept at the Fed. (It later added a subfloor, the overnight reverse repurchase rate, but I’m trying to keep this simple.)