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Can The Fed Control The Fed Funds Rate In Times Of Excess Liquidity?

Mar. 10, 2015 2:32 PM ETSPY, DIA, QQQ, IWM9 Comments
Celan Bryant profile picture
Celan Bryant


  • Fed Vice Chairman Stanley Fischer spoke at the 2015 U.S. Monetary Policy Forum, sponsored by the University of Chicago Booth School of Business on February 27, 2015.
  • The Fed is facing numerous challenges with its current balance sheet.
  • As a result, the Fed is having to rely on other tools like ON REPOs and changes in the IOER to control the Fed Funds Rate.

Ever since the Great Recession the Fed has been pumping money into the economy which has created some new challenges for the Fed in terms of monetary policy. Fed Vice Chairman Stanley Fischer spoke at the 2015 U.S. Monetary Policy Forum, sponsored by the University of Chicago Booth School of Business on February 27, 2015. He used the time to discuss these challenges.

"To set the stage," begins the chairman, "consider the size of the Fed's balance sheet over the past several years. Assets have risen from about $900 billion in 2006 to about $4.5 trillion today."

"The net expansion over this period," he goes on to say, "reflects primarily our large-scale asset purchase programs." He's referring to programs like Quantitative Easing ("QE") that pumped $85 billion into the market every month by buying up bank assets, especially troubled mortgage-backed securities.

The U.S. isn't the only country to focus on liquidity, the Bank of Japan has increased assets from ~20 percent to more than 60 percent of nominal GDP over the same time period, and the Swiss National Bank increased assets from 20 percent to more than 80 percent of nominal GDP. At the ECB, assets increased from less than 10 percent to more than 20 percent of nominal GDP and Europe's Quantitative Easing program hasn't even started.

With all this liquidity in the market the Fed is naturally concerned about inflation, especially if energy prices rebound. They're also concerned about being able to "control" the Fed funds rate which is the rate at which banks lend money to each other. Historically, the rate is controlled by the Fed and used as a way to exact monetary policy. A higher rate meant banks had to pay more interest to borrow money and thus set the floor on rates across the market.

This article was written by

Celan Bryant profile picture
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Comments (9)

Salmo trutta profile picture
Vice Chairman Stanley Fischer
February 27, 2015

"Prior to the financial crisis, because reserve balances outstanding averaged only around $25 billion, relatively minor variations in the total amount of reserves supplied by the Desk could move the equilibrium federal funds rate up or down. With the nearly $3 trillion in excess reserves today, the traditional mechanism of adjustments in the quantity of reserve balances to achieve the desired level of the effective federal funds rate may well not be feasible or sufficiently predictable"

The money stock can never be managed by any attempt to control the cost of credit.
David de los Ángeles Buendía profile picture
Hello Salmo trutta,

The Federal Reserve Bank traded in a fly-swatter for a bazooka. It is hard to swat flies with a bazooka. By the by, the full speech, for the interested reader, is found here...

Salmo trutta profile picture
"The declines in long-term yields have led to an associated drop in long-term borrowing costs for households and firms and higher equity valuations. Thus, the asset purchases have helped make financial conditions overall more accommodative and have PROVIDED SIGNIFICANT STIMULUS for the broader economy"

No, securities held by the Central bank were 2 trillion dollars higher than the volume of new money which was created from OMOs. AD, as the Keynesian’s measure it, N-gDp, averaged 30 percent lower in 2008-2014 than the prior 7 years (2001-2007). Real-gDp (2001-2007), averaged 2.5 percent/annum, or 2.04 X real-gDp during 2008-2014 (1.2%/year).

That's subpar economic growth, or insufficient stimulus.
Celan Bryant profile picture
Noted, and the correction has been made. The SEC doesn't participate in monetary policy so public comment is irrelevant. This was clearly an error and we thank you for pointing that out. That said, the entire post is backed up with actual quotes from Fischer's speech -- it is not an assessment. Fischer questions the Fed's ability himself, directly within the speech which is also provided.
Anybody else notice that Stanley Fischer is Vice Chair of the FED? Not the "SEC Chair" or "Vice Chair"?

Interesting article, but I, for one, tend to call into question any comments or assesments that the poster has made when such basic mistakes are right at the beginning of the post.
Salmo trutta profile picture
"This action should encourage banks not to lend to any private counterparty at a rate lower than the rate they can earn on balances maintained at the Fed, which should put upward pressure on a range of short-term interest rates."

Monumental mistake. Raising the remuneration rate, whereby it extends the duration of the inverted yield curve (daily treasury yield curve rates), will crater the economy.
David de los Ángeles Buendía profile picture
Hello Celan Bryant,

The other side of that equation is the question: It there a market for higher interest rates? Is there enough demand in the credit market to support an increase in interest rates?

Consider the history of the Effective Federal Funds Rate (EFFR)[1]. For a twelvemonth between 2006 and 2007 interest rates were over 5%, but then the EFFR fell nearly 5,000 basis points to 0.28% by November of 2008. The Zero Interest Rate Policy (ZIRP) and the Large Scale Asset Purchase (LSAP) programme did not begin until December of 2008 (see my response to gotothomas above for more details). It is market forces that drove down the EFFR down, not the FRB. The FRB using ZIRP and LSAP only forced down the EFFR an additional 28 basis points to today's rate.

In June of 1981 the EFFR was 19.1%, in June of 1991 it was 6.0%, in June of 2001 it was 3.97%, and in June of 2011 it was 0.11[2]. That is a decline of two orders of magnitude in 30 years. The Federal Reserve Bank (FRB) did not do that, that was the market in action. The decline in the demand for credit is the reason[3]. How much of a rate increase will that market support?

So perhaps the FRB and the Federal Open Market Committee now have a huge, unwieldy set of tools to work. Perhaps the credit market is even more dominated by supply than demand than it was before. Perhaps the marble has changed as have the chisel and hammer and only the sculptor is the same.

[1] http://bit.ly/1v0fqUF

[2] http://bit.ly/136a6Rf

[3] http://bit.ly/1pIzPbQ
The Geoffster profile picture
Banks are an almost irresistible attraction for that element of our society which seeks unearned money.
J. Edgar Hoover
Celan Bryant profile picture
Ha! I'll have to use that sometime. Thanks, Celan
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