Over the course of the Great Moderation, a lot of people forgot the difference
between the Fed funds target rate (that’s the number set at FOMC meetings) and
the actual Fed funds rate (the actual, real, interest rate). No one forgot about
that difference this morning, when the Fed funds rate was standing
at 6%.
Then the Fed put out its statement:
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. In current
circumstances, depository institutions may experience unusual funding needs
because of dislocations in money and credit markets. As always, the discount
window is available as a source of funding.
Let’s backtrack here, for a minute. It wasn’t all that long ago that the Fed
funds target rate wasn’t even public: banks had to work it out in a process
of induction from where the actual Fed funds rate stood. The Fed would essentially
communicate to the market where the target rate was by providing and removing
liquidity until the actual rate got to where it was desired to be.
That mechanism remains, today. The way that the Fed controls interest rates
is by providing extra liquidity when the Fed funds rate rises above the target,
and removing liquidity when the Fed funds rate falls below it. So in that sense
there’s nothing special about the Fed’s statement today: if the Fed funds rate
is at 6% and the target is 5.25%, then it bloody well ought to be injecting
liquidity. And even the Fed, with its slightly snippy "as always"
(Jim Cramer, are you listening?) seems to be communicating
to the market that it’s just doing what it always does.
But the announcement is welcome, all the same. It’s one thing to provide extra
liquidity in theory. When you actually do it in practice in such large amounts,
that’s worth a press release.