FOMC Statement – June 17, 2015

The FOMC released its latest statement on Wednesday.  The big news is that the Fed will keep its target rate between zero and 1/4 percent.  This is the federal funds rate, which is the overnight borrowing rate for banks.

Since the banks have a pile of excess reserves, they don’t need to borrow money overnight to meet reserve requirements.  Therefore, the rate stays near zero.  The only way for the Fed to effectively raise this rate – short of selling trillions of dollars in assets to drain bank reserves – is to pay a higher interest rate on bank reserves.

The key point here is that the federal funds rate – the rate that everyone is talking about – has almost no correlation to the actual money supply at this point.  The Fed can raise its rate, but this doesn’t dictate its control over the money supply as it did in the past.  The Fed can inflate or deflate the money supply, and it will not affect the federal funds rate, unless the deflation were severe.

Perhaps the federal funds rate will impact market interest rates, but that isn’t even clear at this point.  The market has been anticipating a hike by the Fed for quite some time, yet interest rates only just recently went up a bit.  And that was after going down, despite the market’s anticipation of a Fed hike.

The Fed is currently in a tight money mode.  It has been since QE3 ended in late 2014.  But QE3 was huge.  To put this in perspective, QE3 created more money out of thin air than the first 95 years of the Federal Reserve’s existence.

We shouldn’t be worrying so much about the Fed hiking the federal funds rate.  This will just be a further bank bailout.  The bigger questions are what the economy is going to do and how the Fed will respond.

If we have another quarter of negative GDP, then we will be in a recession by definition.  And what happens if the stock market crashes by 30 or 40 percent?  Is the Fed going to sit on its hands?

The real question is whether the Fed will respond to an economic downturn with more QE (monetary inflation).  And if this does happen, will we finally see price inflation show up more significantly?

We will continue to keep our eye on the ball and not the distraction of the federal funds rate.  The money supply is what matters the most.

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