This Blog Has Moved!

My blog has moved. Check out my new blog at

Your Ad Here

Wednesday, October 8, 2008

Federal Reserve Cuts Fed Funds Rate to Zero

This page on the Federal Reserve website was interesting. I'll reproduce the table here, because the Federal Reserve only puts the most recent month on that page, although historic archives are kept.


Explaining the above data, "Target Rate" is the official Fed Funds target of 2%.

"Daily" is the daily average and "Std. Dev" is the standard deviation during the trading day. "Low" is the lowest value for the Fed Funds Rate during the day, and "High" is the high value.

The Fed Funds Rate is the rate that banks charge each other for surplus reserves. Banks with extra reserves loan them to other banks. Banks with more (loans+required reserves) than deposits borrow at the Fed Funds Rate. Banks borrow from other banks. Certain large banks may borrow directly from the Federal Reserve when it "monetizes the debt".

Via the "monetizing the debt" trick, the Federal Reserve creates enough bank reserves so that the Fed Funds Rate is near its official target. During a "liquidity crisis", the Federal Reserve may create extra reserves and the Fed Funds Rate will drop below the official target. Due to the Compound Interest Paradox, the Federal Reserve must create new bank reserves almost every day.

Starting September 15, the Federal Reserve really got aggressive "injecting liquidity". The "low" value of the Fed Funds Rate dropped to 0% on many days. For the last week of September and the first week of October, the average Fed Funds Rate was much lower than the "official" target of 2%.

When the Federal Reserve "monetizes the debt", only certain large banks trade directly with the Federal Reserve. These banks got the perk of borrowing at 0%. Later in the day, smaller banks borrowed from the larger banks at a value closer to the official Fed Funds Rate target of 2%.

The 1 month and 3 month Treasury Note yield rate has dropped to nearly zero. Recently, some Treasury debt traded for more than par; i.e., someone paid more than $10,000 for a $10,000 face amount bond. The Federal Reserve announced that it would let banks earn interest credited on surplus reserves. This move is only needed because the Fed Funds Rate dropped to zero. Normally, banks with surplus reserves lend them to other banks.

The "official" Fed Funds Rate is used as a base for other loans, such as the prime lending rate for large corporations. By cutting the actual Fed Funds Rate, but not the official target, the Federal Reserve is subsidizing the profits of large banks.

Even if there were no explicit Federal government bailout of the banking industry, the Federal Reserve still subsidizes bank profits by inflating the money supply and cutting interest rates. The actual size of the banking industry subsidy is much greater than the amount directly allocated by Congress.

The Federal Reserve literally has an infinite budget, so it may set the Fed Funds Rate at any level it chooses. The Federal Reserve's operations aren't free. Everyone else pays the cost as inflation.

1 comment:

Anonymous said...

Why would they buy a bond at greater than face amount?

This Blog Has Moved!

My blog has moved. Check out my new blog at