In an article on the Federal Reserve’s mythical September taper, which the financial media invented last June and never challenged, the editors at Bloomberg wrote this.
How, then, can the Fed give companies the confidence they need to hire and invest, and get the market’s mind off tapering? A clue can be found in the economic projections the central bank published together with today’s policy statement. They show that most Fed officials expect their short-term interest-rate target to remain at or below 2 percent at the end of 2016, much lower than their forecast for unemployment suggests it should be. In other words, as Fed Chairman Ben Bernanke has said, they’re ready to keep stimulus going for long after the unemployment rate drops below the 6.5 percent threshold they have set for interest-rate increases.
If the Fed wants to make a bold statement, it can take those plans and turn them into a promise: The central bank will keep interest rates below 2 percent until the end of 2016, no matter what happens with jobs or inflation. Such simple, clear policy guidance would help focus the market’s attention and erase employers’ and investors’ concerns that the Fed will reverse course just as the recovery is gaining momentum — worries that the Fed’s changing tapering schedule have only served to encourage.
To understand this supposed policy of holding to a short-term interest rate target of 2%, consider this.
Every six weeks, the FOMC issues a boilerplate press release. As part of that press release, there is a section on interest rates. The only reference is to the federal funds rate, the rate at which commercial banks lend money to each other overnight. That figure never changes in the press release: 0% to 0.25%. This rate has not been above 0.25% since late 2008.
The FED in fact has not controlled this rate since 2008. The commercial banks have. Because they are sitting on $2 trillion of excess reserves, banks rarely borrow money overnight. They do not have to. They have plenty of reserves.
Before late 2008, a bank would borrow overnight if its reserves threatened to fall below the legal requirement set by the FED. But now banks have so many reserves that they rarely borrow. So, there is little demand. So, the rate is low.
The FOMC has increased the monetary base at times. In most of 2012, it decreased it. The FedFunds rate has not changed when FOMC policy has changed.
Here is the inescapable conclusion: the Federal Reserve does not control this rate.
The FED pretends that it does. Here is what it writes every six weeks.
To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.
This is what it said on September 18, July 31, May 1, March 20, January 30, and December 12, 2012. I have chronicled this here.
The FOMC might just as accurately have written this. “The Committee has decided to retain the law of gravity, and currently anticipates that Brinks armored vehicles will not float into the stratosphere in the immediate future.”
The economists at the Federal Reserve like to pretend that the FED is in charge of the FedFunds rate: day to day, week to week, even month to month. This self-confidence reinforces their belief that they really are worth the above-market salaries they are paid. The Federal Reserve creates money out of nothing to buy Treasury debt, which pays interest, which the FED then uses to pay above-market salaries to its staff.
Staff economists at the FED are useful to the FED for the same reason that this machine was important to the Wizard of Oz.
The FED’s control over the FedFunds rate has been mythical ever since the financial crisis of late 2008. Frightened commercial bankers have turned over excess reserves to the FED. The FED accepts these reserves. That is the extent of the FED’s control over the FedFunds rate.
The officials at the FED pretend that they control this rate, and the financial media parrot them.
This is the state of financial journalism today. This is almost as naive and misleading as Federal Reserve economists, who think the FED’s monetary policy controls the FedFunds rate.
From now on, every time you read about the FED’s control over short-term interest rates, remember this video.