It’s not 0%, but rather a "target range", which sounds like somewhere you go to fire a gun. I can kinda see what the Fed is driving at here: given the difficulty of using open-market operations to set the Fed funds rate when it’s so low in nominal terms, a range is easier to hit than a target.

I don’t like this — not unless the Fed really cracks down on fails-to-deliver in the repo market. If rates are at 0% and there aren’t any penalties for failing to deliver Treasury bonds, then fails are going to rise even further, and faith in the repo market could evaporate very suddenly, with catastrophic knock-on effects. There could also be nasty unintended consequences for money-market funds.

In any case, it’s not like the Fed needs to use the Fed funds target rate as its foremost monetary-policy instrument: as Alea notes, it’s good at using its balance sheet instead.

Here’s his annotated Bank of Canada chart: the smaller arrow, on the left, is Bear Stearns; the larger one, on the right, is Lehman Brothers. It’s this, just as much as rate cuts, which is really responsible for the monetary easing we’ve seen in recent months.


Obviously the more-than-trillion-dollar expansion in the Fed’s balance sheet has happened post-Lehman, but it’s also worth noting the $300 billion decline in the Fed’s Treasury holdings since Bear.

It’s also interesting to note that the repo operations which the Fed embarked upon post-Bear have more or less disappeared at this point. That’s not good for the repo market either. Meanwhile, the currency-swap facility, which I think is mainly with the ECB, is absolutely enormous and accounts for a plurality of Fed assets.

In any case, you can be sure that the Fed’s balance sheet is going to expand even more in 2009:

As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities. Early next year, the Federal Reserve will also implement the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses. The Federal Reserve will continue to consider ways of using its balance sheet to further support credit markets and economic activity.

Did we really need a zero interest rate policy, or Zirp, on top of this? It would be great if we could get some reassurance from FOMC members that they understood the downside of today’s move and know what they’re doing. Because it really worries me.

Update: The FT reports on the parlous state of the repo market. (Via Matt Tubin, in the comments.)

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