I noticed a link to the latest fodder for criticism by financial reporter John Schoen on CNBC’s homepage today. It’s titled How does the Fed raise interest rates? I had a good laugh at its expense and then I cried over how terrible it is. Just imagine the poor people who don’t know anything about how this happens walking away with their IQ’s permanently lowered.
It’s good for borrowers. That’s why the Fed has been having a giant money sale since late 2008 when the bottom fell out of the global financial system. Since then, cheap dollars have flooded through the mortgage market (reviving a dead housing market), the stock market (rebuilding the damage to pensions and 401(k)s) and the bond market (helping companies and governments save money by refinancing their debts at much lower rates.)
Once the Fed started buying every bond that wasn’t nailed down, rates dropped to low single digits and stayed there. Now that the Fed has ended its bond shopping, rates are expected to begin rising again. So far that hasn’t happened. But in the past, when the Fed wanted to raise long-term rates, it started selling some of its bond holdings.
For that [short term rates], the Fed has a more immediate mechanism handy in its role as the overseer of the nation’s banking system. It’s called the federal funds rate.
That’s the rate banks charge each other for very short-term loans, usually overnight. The Fed can change that rate with a simple announcement at a moment’s notice, though these days it’s giving everyone plenty of advance warning. And, when it finally moves, it’s expected to raise that rate in baby steps.
By changing the rate on what banks charge each other for those overnight loans, the Fed has an immediate impact on the interest rates banks charge you. That change moves through the economy quickly.
The Fed sets another bank rate called the discount rate, which is what it charges banks to borrow directly from the Federal Reserve system. But banks have lots of other sources of ready cash (starting with other banks), so change in the discount rate usually has a much smaller impact.
The exception is in times of crisis, when the financial system is in trouble and banks have trouble borrowing elsewhere. That’s one of the main reasons the Fed was created 100 years ago, to be the lender of last resort.
Really?? Is this how the Fed raises interest rates?
If, as Milton Freidman said, higher interest rates is a sign that money has been easy, then I think Mr. Shoen has a logic problem and doesn’t quite get the gravity of the ACTUAL situation when he says that rates should naturally rise but that “so far, that hasn’t happened.” And the reason it hasn’t happened is because money hasn’t been easy in any shape or form.
Even Bernanke said that interest rates are not a reliable indicator of the stance of monetary policy, and for that we need to look to NGDP growth and inflation. It sure isn’t the case that NGDP has been on a tear lately – and inflation has been dead for years.
There has been no money sale. There was lots of QE and the ZLB in the Great Depression, and it didn’t help.
It would be nice if CNBC could get someone who has even a slight clue about what’s going on to do their “CNBC Explains” series. Because if it did, we may not be having such a problem with people getting away with just saying anything inside the Fed with average people having a chance to actually learn the nature of the current reality.
PS: If the Fed does try to raise interest rates in the current kind of environment it will succeed for a very short period, and then we will likely end up right back where we started. It will have to back off or we get to turn Japanese.