Fussing With The Funds Rate

The Fed keeps missing its target

On Jan. 31, the Federal Reserve Board's Open Market Committee confirmed market expectations by lowering its target for the federal funds rate--the interest rate that banks pay to borrow overnight money from one another--by 25 basis points, to 5.25%. So what's happened to the funds rate?

As economist William V. Sullivan Jr. of Dean Witter Reynolds Inc. points out, in the 17 trading days following its announcement, the Fed was able to meet or exceed its target on only two occasions. On the 15 other sessions, the effective funds rate averaged a full one-eighth of 1% below the Fed's target.

At the least, this suggests that the U.S. financial system is awash with liquidity. Sullivan thinks one reason may be the recent tendency of commercial banks to attract more cash into savings accounts and to tap other sources such as large certificates of deposit--thus lessening their reliance on federal funds.

But even with this shift, notes Sullivan, a fundamental question remains: Does the lower-than-targeted funds rate reflect a desire by the Fed to be slightly more accommodative than its stated intention--or does the flood tide of cash reflect an unanticipated further slowing of the economy?

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