| Federal Reserve officials are moving slowly in discussions about how to manage the mechanics of interest rate increases once they decide to start tightening credit. |
| A number of officials, in interviews and public comments following the Fed’s last policy meeting, suggested they have not moved forward on a range of technical decisions they’ll need to make before proceeding on rate increases. Among those questions: What will the Fed’s first rate move look like? The central bank says that it aims to keep its target for its benchmark federal funds rate in a range between 0 and 0.25%. The rate sits just below 0.10% most days. |  |
| When the Fed first raises the rate, it will have several choices. It could first firm the rate at the upper end of that range, 0.25%, and proceed later to lifting it higher. Alternatively, it could go straight to a higher level of 0.5%. Or it could lift the fed funds rate from a range of 0 to 0.25% to a range of 0.25% to 0.5%. Dennis Lockhart, president of the Federal Reserve Bank of Atlanta, said in an interview with the Wall Street Journal this week he could envision the Fed first moving to firm the fed funds rate around the upper end of the central bank’s target range, at 0.25%, before moving it higher. Mr. Lockhart added he was in no hurry to make decisions. Because he doesn’t see the Fed moving short-term rates up from near zero until the second half of 2015, the issue isn’t pressing, he said. “I think it’s a little premature to have every technical detail ironed out at this time,” Mr. Lockhart said. The decision is meaningful — if not imminent — because it could shape the timing and pattern of subsequent Fed rate moves. Most Fed officials believe the central bank will move rates higher sometime next year, though they haven’t been clear about exactly when. Investors became more focused on the timing after the Fed’s policy meeting last week, when it changed its guidance for the interest rate outlook and updated forecasts for rates in 2015 and 2016. “I don’t have an answer at this point,” Minneapolis Fed president Narayana Kocherlakota said in a recent interview when asked if the Fed should firm the fed funds rate around 0.25% before moving it higher. “I haven’t thought that through.” The fed funds rate, charged on overnight loans between banks, is the Fed’s primary tool for influencing the cost of credit throughout the economy. The Fed lowered it to near zero in December 2008, in the midst of the financial crisis, to stabilize the financial system. The Fed has held it there since to try to boost economic growth. Many other interest rates set by the market are benchmarked to the fed funds rate, so when it goes up other borrowing costs throughout the economy will rise too. A big technical issue for the Fed is whether to keep relying on the fed funds rate as its primary tool for adjusting interest rates. One potential alternative involves a new program being tested by the Federal Reserve Bank of New York. In this program— which uses reverse repurchase agreements known as reverse repos — the Fed uses its large portfolio of securities as collateral for short-term loans from money market mutual funds, securities firms, and others. The rate it pays on these loans in theory could set a floor on other short-term interest rates and become a new Fed benchmark interest rate. If the Fed does rely on reverse repos, officials will need to decide what to do with the federal funds rate. Because many other interest rates are benchmarked to the fed funds rate, officials have an incentive to keep using it. But the reverse repo market has the potential to become a much bigger and more liquid market, involving a wider array of market participants, which could make it preferable. A third rate — the rate the Fed pays to banks on the excess reserves they park at the central bank — is also a tool officials expect to use to manage interest rates in the future. The fed funds market has become a quirky market since 2008, when the Fed flooded the financial system with reserves and started paying banks a low rate of 0.25% on reserves they didn’t lend out. Banks now are not very active in the fed funds market and it is not clear how active it will become when the Fed tries to push rates higher. New York Fed President William Dudley said in an interview with the Wall Street Journal earlier this month it is possible the Fed could use reverse repo trades to create a new floor on rates, but that he wanted to continue testing the program before making a decision. “It is too soon for us to reach a judgment about whether that is the right way to go,” Mr. Dudley said. |
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