If a ship crossing a wide and placid harbor yaws so far that it almost hits the channel markers, its captain might want to have the rudder adjusted. That’s essentially what the Federal Reserve has done three times since 2018. With the fed funds rate inching disconcertingly close to the top of the central bank’s target range, it chose to make unprecedented changes in June, December and May to one of its associated policy-setting tools: the interest on excess reserves rate. Now, following the latest tweak to IOER, as it’s known, market observers will be watching to see if the gap between fed funds and the upper bound of the central bank’s target range narrows again. That potentially sets the stage for further adjustments, although there are also questions: How much more can they keep tinkering? Do policy makers need another tool?
In December 2015, the Fed responded to improving economic conditions by raising interest rates that it had cut to near zero during the financial crisis. Since then, it’s increased the range another eight times, to 2.25 percent to 2.50 percent currently. For most of that time, the effective fed funds rate -- the average of what borrowers in the market actually paid -- rested comfortably near the range’s midpoint, just like it’s supposed to. But since the beginning of 2018, fed funds has been creeping higher. It was just five basis points below the top end of the range before the IOER adjustment in May 2019. Right after, the gap widened to nine basis points.
