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by Causes | 9.18.19

Federal Reserve Chairman Jerome Powell announced Wednesday that the central bank’s board of governors voted 7-3 in favor of lowering the federal funds rate by 0.25% to a new target range of 1.75% to 2%, the first time in 2019 the rate will be at or below 2%. The Fed’s second rate cut of the year is the same size as the first cut, which was announced in July and similarly enacted out of concern about global trade uncertainty that’s weighing on an otherwise strong U.S. economy.

In a press conference, Powell said that if the economy weakens the Fed may embark on a “sequence” of interest rate cuts, but that it’s not necessary at the moment:

“If the economy does turn down, then a more extensive sequence of rate cuts will be appropriate. We don’t see that it. It’s not what we expect.”

The Fed’s report explained the cut:

“Job gains have been solid, on average, in recent months, and the unemployment rate has remained low. Although household spending has been rising at a strong pace, business fixed investment and exports have weakened… This action supports the Committee’s view that sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective are the most likely outcomes, but uncertainties about this outlook remain.”

Of the three governors who cast dissenting votes against today’s cut, two wanted to keep the federal funds rate at the current target of 2% to 2.25%, while one wanted a steeper cut to a target of 1.5% to 1.75%.

What is the Federal Reserve?

The Federal Reserve System serves as the U.S. central bank and carries out monetary policy. It’s responsible for managing the nation’s money supply by influencing interest rates to promote stable prices and maximum employment ― objectives known as the “dual mandate”.

How does the Fed carry out monetary policy?

The Fed has three major tools at its disposal:

\nOpen Market Operations, which directly affect the money supply, include the buying and selling of U.S. Treasury bonds to influence the interest rate up or down — whichever is more desirable given economic conditions. When the Federal Reserve buys bonds, the money supply grows and interest decreases. Conversely, when it sells bonds, the money supply shrinks and interest rates rise.
\nChanges in the discount rate (aka the federal funds rate), which is the interest rate that Federal Reserve Banks charge depository institutions for short-term loans.
Modifying the reserve requirements for depository institutions — which is the ratio of reserves to deposits those institutions are required to maintain in their vaults or on deposit at a Federal Reserve Bank.

In general, if the economy is growing rapidly and there are concerns about inflation rising to a level that erodes consumers purchasing power, the Federal Reserve might raise interest rates and shrink the money supply. It can also attempt to rein in the availability of credit through reserve requirements and the discount rate.

On the flip side, if the economy is in recession or sluggish, the Federal Reserve will attempt to broaden the money supply and lower interest rates to encourage economic growth. Meanwhile it can make credit more available to businesses and consumers by easing reserve requirements.

How does the federal funds rate work?

The federal funds rate is the interest rate at which banks or credit unions lend reserve balances to other depository institutions on an overnight basis to maintain their reserve requirements in their vaults or on deposit with the Federal Reserve.

Because lenders indirectly base their interest rates for everything from mortgages to car loans and credit cards on the federal funds rate, as it rises and falls it impacts borrowers throughout the economy.

As this chart from our partners at USAFacts shows, prior to the Fed raising the federal funds rate in late 2015 it had been near zero since the onset of the 2008-09 recession. In 2017, the federal funds rate averaged 1%.

How is the Fed structured?

The Fed is led by the Federal Reserve Board of Governors, which is an independent federal agency whose seven members are appointed by the president and confirmed by Senate. The Fed chair is the leader of the Board of Governors and serves for terms lasting four years after their confirmation.

The Board of Governors conducts oversight of the 12 regional Federal Reserve Banks, which serve as the Fed’s operating arms. Decisions about carrying out monetary policy are made by the Federal Open Market Committee which includes the Board of Governors (and is led by the Fed chair), the president of the New York Fed, and four of the other 11 regional Fed presidents who serve one year terms.

Currently, the top job at the Fed is held by Chairman Jerome Powell, who was confirmed in January 2018 after serving as a member of the Board of Governors since 2012.

What makes the Fed controversial?

There are several areas where Federal Reserve critics express their concerns:

Free-market advocates take issue with the Federal Reserve's role in managing the economy. They argue that its manipulations distort interest rates from the market's true equilibrium — leading to 'bubbles' and over-investment such as the dot-com bubble or the subprime mortgage bubble.
Other critics point to policies that they say help fuel economic inequality — where the wealthy see their assets grow at a faster rate, while the average person's income remains stagnant.
Former Federal Reserve Chairman Ben Bernanke isn't persuaded by claims the Fed fuels inequality — he believes that remedying inequality isn't an attainable goal of monetary policy (other than through job creation). He also foists the blame onto other long-term structural causes of economic inequality like globalization, demographics, and technological progress.

— Eric Revell

(Photo Credit: federalreserve via Flickr / Public Domain)

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