When the FOMC releases a new statement on monetary policy, I often comment, just as I did this past Wednesday. One of the things I mentioned is that the FOMC increased its targeted federal funds rate by 0.25% to a range of 1.75% to 2%. I also stated that the interest rate that the Fed pays to banks on their reserves was raised by only 20 basis points, or 0.20%.
Regarding this slight deviation, I stated the following: “This is more a curiosity than anything, but perhaps the Fed didn’t raise its target rate quite as much as stated. The range of the federal funds rate went up 0.25%, but the interest paid to banks went up 0.20%.”
It turns out that the Fed chair, Jerome Powell, actually commented on this fact, and CNBC ran an article about it.
The article states, “The interest rate on excess reserves, known as the IOER, is now 1.95 percent while the funds rate was set in a target of 1.75 percent to 2 percent. The Fed sets the IOER at the high end of the funds range to keep the benchmark rate in check, but the difference between the two has narrowed sharply in recent weeks. The Fed hopes that a lower increase in the IOER will hold back the funds rate.”
It goes on to state, “Fed officials aren’t sure why the funds rate had been rising to the top end of its range. While there’s a belief that it is in large part due to increased issuance of short-term Treasury bills to pay for the increase in government spending, Fed Chairman Jerome Powell said Wednesday that uncertainty remains.”
In regards to the deviation, the Fed chair actually stated, “The truth is we don’t know with any precision.”
In other words, the Fed has no idea why this deviation has occurred, and its only reasoning is to blame it on the increased issuance of short-term Treasury bills. But since the deficits will likely continue to increase, then there should be a continued increase in the issuance of short-term Treasury bills, especially as the Fed continues to be a net seller of them.
It’s not that I ever had a lot of confidence in the officials working at the Fed, but I thought they at least sort of knew what they were doing. Now, I am less sure. The Fed used to target a specific rate for the federal funds rate, such as 1.75%. Now it uses a range, and it is having trouble just staying inside that range. And this is during a time of seemingly little turmoil in the financial markets. What will happen when the next financial crisis comes?