Tuesday, December 16, 2008

The ACTUAL Fed Funds Rate is Already ZERO

WASHINGTON POST -- The Federal Reserve is widely expected this afternoon to cut interest rates for the 10th time in just over a year, driving the rate it controls close to zero as it continues the most sweeping effort to stabilize the economy in the history of the central bank.

The federal funds rate, at which banks lend to each other, is already at 1%. The Fed is expected to drop it to half a percent, or even lower, at the end of its policymaking meeting today. That would be the lowest U.S. rate on record.

MP: The Post article above illustrates some widespread confusion about: a) the TARGET Fed Funds rate (currently at 1%), and b) the ACTUAL Fed Funds rate (currently close to 0), see chart above (click to enlarge) using Fed data. The actual Fed Funds rate is determined by banks borrowing and lending bank reserves, so it generally a market-determined rate that can deviate from the intended target rate. The Post article should have said "The TARGET federal funds rate is already at 1%," and it could have been clarified that the ACTUAL rate at which banks actually lend to each other is closer to .25%, not 1%.

Notice that in October when the target Fed Funds rate was 1.5% (blue line), the actual Fed Funds rate was about 1% (red line). For the last two months, the target Fed Funds rate was 1%, while the actual Fed Funds rate has ranged between about .50% and close to zero, probably averaging about .25%.

At its meeting today, the FOMC is expected to cut its target Fed Funds rate again. But if the actual Fed Funds rate is already close to zero, will it really have any effect? Can it really have any real effect?


At 12/16/2008 9:50 AM, Blogger stilettoheels said...

But if the actual Fed Funds rate is already close to zero, will it really have any effect? Can it really have any real effect?

No. You already knew that ZIRP and quantitative easing have been ripe with pregnancy for many months.

The market isn't hanging on the cut, it's hanging on the statement.

How are housing starts shaping up? Maybe you should produce another of your charts adjusting for outstanding households since 1959.

How about another on consumer price deflation since 1947?

Time to change your tune, no?

At 12/16/2008 1:30 PM, Blogger misterjosh said...

This also illustrates my ignorance. What is the point of a target rate? How can the fed affect the actual rate? If lowering the "target" rate will evidently have no practical effect on the actual rate, is it just a publicity move? "ease fears" etc.

As to Prof. Perry's tune, ya gotta admit that it still isn't that bad yet. I think it's going to get much much worse, but status quo is pretty darn good compared to the 30s.

At 12/16/2008 5:17 PM, Anonymous Anonymous said...

If banks are scared to lend right now, why is the actual rate below the target rate? Shouldn't it be the opposite?

At 12/16/2008 8:03 PM, Blogger Arnett W. Rebuff said...

What is the difference between the Monetary base and M1. Why does M1 seem rather stable while the monetary base is exploding??


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