Thursday, June 25, 2009

Back to Zero

As we surmised the other day, the Fed has decided to take a hands-off policy to further tinkering with interest rates, at least for the moment. After its two-day meeting, the Fed board announced that "the pace of economic contraction is slowing," and left the Fed Funds rate at zero.

What exactly is the Fed funds rate? One of the key ways the Federal Reserve System manages our monetary policy, the federal funds rate is the rate that banks are charged for overnight loans of federal funds, which are the reserves held by the Fed. With the Fed funds rate at zero, banks can borrow short-term money from the Federal Reserve at 0 percent interest. A rate that low makes it as easy as possible for banks to lend money and pump more funds into the economy. Loans for businesses to establish themselves or expand - if shellshocked banks are willing to offer them - should be available at very low rates.

The Fed dropped the rate to zero back in December 2008, and it's stayed there ever since. It's the first time in history that the rate has ever been at zero. The fact that the zero rate hasn't brought the economy roaring back to life shouldn't be taken as evidence that this policy was a failure; there's no telling how much worse things would be with a higher Fed funds rate.

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