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Fed supplies $38B to aid stock market

Central bank provides liquidity in three separate operations Friday in an effort to stabilize money supplies.

WASHINGTON (Reuters) -- The Federal Reserve injected a total of $38 billion into the banking system Friday, saying it was providing liquidity as needed to keep financial markets operating normally.

"The Federal Reserve is providing liquidity to facilitate the orderly functioning of financial markets," the Fed said in a statement.

The central bank's statement was issued shortly after the Fed added liquidity into the banking system for a second day by adding $19 billion of temporary reserves through repurchase agreements.

Later in the morning, the Fed injected an additional $16 billion in its second repurchase operation of the day.

It conducted a third repurchase move of $3 billion, which drove the Fed funds rate down to 5.00 percent, below its target of 5.25 percent.

Just a day earlier, the Fed provided $24 billion through two separate operations.

In its statement issued Friday, it said: "The Federal Reserve will provide reserves as necessary through open market operations to promote trading in the federal funds market at rates close to the Federal Open Market Committee's target rate of 5-1/4 percent."

The Fed acknowledged that some banks might encounter some difficulties amid current market turmoil.

"In current circumstances, depository institutions may experience unusual funding needs because of dislocations in money and credit markets," the Fed statement said.

It added that, as always, its discount window was open as a source of short-term funds for banks.

The Fed added the temporary reserves to the banking system through three-day repurchase agreements.

The mechanics of money

The Fed's Open Market Desk monitors the rate at which banks loan each other funds. When this amount goes higher than the Fed's goal - currently 5.25 percent - the central bank moves to put more money into the market.

It agrees to buy government Treasury bonds from its primary dealers - big banks like Goldman Sachs and Citigroup. To make the purchase, it deposits money from the sale - in this case $35 billion - with dealers, who in turn lend the funds on the open market. The agreement is essentially a substantial short-term loan by the Fed.

The move increases the money supply and drives interest rates down. The Fed can also try to raise interest rates by borrowing money from the reserve accounts of primary dealers, in the event that the rate drops below its target. Top of page