Explanation of Federal Funds Rate Decisions
When the Federal Open Market Committee wishes to reduce interest rates they will increase the supply of money by buying government securities. When additional supply is added and everything else remains constant, price normally falls. The price here is the interest rate (cost of money) and specifically refers to the Federal Funds Rate. Conversely, when the Committee wishes to increase the Fed Funds Rate, they will instruct the Desk Manager to sell government securities, thereby taking the money they earn on the proceeds of those sales out of circulation and reducing the money supply. When supply is taken away and everything else remains constant, price (or in this case interest rates) will normally rise.
The Federal Reserve has responded to a potential slow-down by lowering the target federal funds rate during recessions and other periods of lower growth. In fact, the Committee's lowering has recently predated recessions, in order to stimulate the economy and cushion the fall. Reducing the Fed Funds Rate makes money cheaper, allowing an influx of credit in to the economy through all types of loans.
The charts linked below show the relation between S&P 500 and interest rates.
- July 13, 1990 — Sept 4, 1992: 8.00%–3.00% (Includes 1990–1991 recession) rate drop chart rate rise chart
- Feb 1, 1995 — Nov 17, 1998: 6.00–4.75 rate drop chart1 rate drop chart2 rate rise chart
- May 16, 2000 — June 25, 2003: 6.50–1.00 (Includes 2001 recession) rate drop chart1 rate drop chart2 rate rise chart
- June 29, 2006 — (Oct. 29 2008): 5.25–1.00 rate drop chart
- Dec 16, 2008: 0.0–0.25
Bill Gross of PIMCO has suggested that in the past 15 years, every time the fed funds rate was higher than the nominal GDP growth rate, assets such as stocks and/or housing always fell. He even suggested that the best way to price the fed funds rate would be 100 basis points, or 1%, below the nominal GDP growth rate.
Read more about this topic: Federal Funds Rate
Famous quotes containing the words explanation of, explanation, federal, rate and/or decisions:
“There is a great deal of unmapped country within us which would have to be taken into account in an explanation of our gusts and storms.”
—George Eliot [Mary Ann (or Marian)
“To develop an empiricist account of science is to depict it as involving a search for truth only about the empirical world, about what is actual and observable.... It must involve throughout a resolute rejection of the demand for an explanation of the regularities in the observable course of nature, by means of truths concerning a reality beyond what is actual and observable, as a demand which plays no role in the scientific enterprise.”
—Bas Van Fraassen (b. 1941)
“It is odd that the NCAA would place a school on probation for driving an athlete to class, or providing a loan, but would have no penalty for a school that violates Title IX, a federal law.”
—Cardiss L. Collins (b. 1931)
“You are more than entitled not to know what the word ‘performative’ means. It is a new word and an ugly word, and perhaps it does not mean anything very much. But at any rate there is one thing in its favor, it is not a profound word.”
—J.L. (John Langshaw)
“No one ever promised me it would be easy and it’s not. But I also get many rewards from seeing my children grow, make strong decisions for themselves, and set out on their own as independent, strong, likeable human beings. And I like who I am becoming, too. Having teenagers has made me more human, more flexible, more humble, more questioning—and, finally it’s given me a better sense of humor!”
—Anonymous Father. Ourselves and Our Children, by Boston Women’s Health Book Collective, ch. 4 (1978)