The Fed Funds Target Rate Is an Exercise in Futility

Time again for another underwhelming FOMC meeting. As I said before the last FOMC meeting, in The Fed Funds Target Rate is an Exercise in Futility, we are so close to the zero bound that further easing will do little. Here’s a graph of effective Fed funds:

That is not to say that the Fed is out of options, but the FOMC and what it has to say, matters less and less. The various lending programs of the Fed are where the action is, where they monopolize liquidity for the markets they deem worthy of service, while starving everything else of liquidity.

As others have commented, and I can’t remember where, the low Fed funds rate reduces the powers of the regional Federal Reserve banks, and raises the power of the NY Fed and the Board of Governors, because the regional Federal Reserve banks don’t have much play in the new lending programs.

The low fed funds rate affects high credit quality money market funds, many of which will close to new investments (and/or reduce fees). Otherwise, the low rates may cause them to “break the buck.” As it is, rates will be near the zero bound for a long-ish time, unless we get a spate of inflation due to dollar depreciation.

Comments

[jadziasman:]

Seems as if the Fed is deliberately trying to debase the dollar so that the general price level increases. The fear in D.C. and at major banks is the continuing problem with depressed home values, which will create havoc in 2010 and 2011 when the Alt-A's and Option ARM's reset. If the Fed is successful and its inflation strategy artificially increases home values enough to allow the mortgage holders to refinance, then the Great Recession can be finally put to rest.

The danger in this strategy is that interest rates are liable to be in the 7 to 8% range in 2011 making the mortgages unaffordable for those with high loan to value ratios or inadequate incomes to cover the higher payments.

Although inflation is never desirable, it might be the medicine needed at this moment in time no matter how bad it tastes.

2008 Dec 16 07:35 PM

[Asbytec:]

Jadzi, you are right. They are trying to inflate us out of recession and stave off the threat of deflation. And the author is right, in my view. A rate cut below 1% will only serve to kill the dollar, nothing more.

I supported Bernanke's actions, as I think I understand the crisis. But, I think he's overshot interest rates. I woke to the rate cut news and am just flabbergasted. My wealth depends on a strong dollar, and I am now officially in recession. Interesting times.

2008 Dec 16 09:13 PM

[Moon Kil Woong:]

Yes, however, look at how it is done. Basically, the fed backs money market, hedge funds, and other instruments but encourages a mass flee from them as rates drop. As depositors leave basically the lights go out. That leaves only the Fed and treasuries (paying - interest) and banks that need to pay CDS and CDO debt. And the Fed uses treasury money to back the banks.

So although the base money supply is increased it just goes to help the bankers. You, on the other hand get to starve. I hope you had money saved under your pillow. If not try your kid's piggy bank.

Don't worry about inflation yet. Worry about winter. The Fed (Paulson) and Treasury (Bernake) are the Grinch not Santa Claus.

Paulson actually was a main perpetrator in issuing CDS contracts while at Goldman Sacs (profiting to Goldman at the loss to their clients until their clients refused to pay or went virtually bankrupt like AIG). He has been a architect of financial catastrophe not a savior. Bernake is about as clueless as you get. Dupish. Everyone loved him when he said he didn't mind printing free money and giving it to financial institutions in a catastrophe. That is exactly why he was hired and exactly what he is doing now.

2008 Dec 16 09:53 PM

[Asbytec:]

It is done, and we're entering into a new era. I felt it on the news we went to zero and trashed the dollar. Judging from the blogs, I guess many felt it right in our collective gut. Have any idea what that new era might be? LOL

2008 Dec 17 09:02 AM

[Smarty_Pants:]

It's a new era all right. It seems that helicopters weren't sufficient for the job at hand. For an idea of what that means see here:

www.321gold.com/editor...

Be sure you don't miss the photo on that link. It's sure to make you chuckle a bit before you groan at the thought of the implications.

2008 Dec 17 09:38 AM

[jimmy46:]

Of course the FED wants inflation,

It's conventional wisdom that without inflation,
the FED can't manipulate the economy by changing interest rates.

Right now they're feeling impotent.

2008 Dec 19 02:18 PM