US Fed interest rate policy: a brief history

Reuters New York | Updated on January 22, 2018 Published on September 17, 2015

World stock prices held near three-week highs and the U.S. dollar fell on Thursday as investors waited to hear whether the US Federal Reserve will end its near-zero interest rate policy.

Following is some background on the Fed's benchmark policy rates.

* An increase in the fed funds target rate would be the first since June 2006 and would signal an end to an era of extraordinary monetary policy accommodation, during which the U.S. central bank cut interest rates to near zero and flooded the banking system with about $3.6 trillion in cash through a series of asset-purchase programs.

The Federal Open Market Committee (FOMC), the Fed's monetary policy-setting panel, has kept the target range for the federal funds rate at 0.00 - 0.25 per cent since December 2008.

An increase in the fed funds rate would likely prompt US banks to change their prime rate, or the rate charged to its best customers for loans. The prime rate is currently 3.25 per cent and is typically three percentage points above the top end of the targeted range for the federal funds rate.

The federal funds target rate is the target rate charged between U.S. banks for overnight loans needed to maintain their required reserve balances. The FOMC meets eight times a year to assess the health of the economy and decide what policy actions are needed to meet its two congressionally established mandates: fostering maximum employment and price stability.

The Fed considers the federal funds rate to be its primary policy tool for pursuing those two mandates. The Fed stands nearly alone among first-tier central banks in having a divided, or dual, mandate. Most of its peer banks are charged only with maintaining price stability by capping inflation, while preventing deflation.

Like most of its peers, the Fed considers a core inflation rate, excluding food and energy inflation, of about 2.0 per cent as being consistent with its price stability mandate.

At present, the Fed does not have a specific target for the unemployment rate at which it considers the US economy to have achieved its full or maximum employment mandate. However, after the 2008 financial crisis the Fed explicitly linked its policy with attaining an unemployment rate of 6.5 per cent until 2014.

The Fed is also responsible for another important interest rate: the discount rate. This is the rate charged to U.S. banks for emergency loans directly from their local Federal Reserve bank branch. This rate is set by the boards of directors of the 12 regional Federal Reserve banks and is subject to approval by the Federal Reserve Board of Governors, not the FOMC. Because it is a penalty rate, it is always higher than the federal funds rate and is currently set at 0.75 percent.


* The last increase in the federal funds rate by the FOMC was on June 29, 2006, when it raised the rate to 5.25 per cent from 5.00 per cent, concluding a run of two years during which the FOMC had increased the rate by a quarter percentage point at each meeting beginning on June 30, 2004, when it raised the rate from 1.0 per cent, then a historic low, to 1.25 per cent.

* The FOMC left the federal funds rate unchanged at 5.25 per cent from June 29, 2006, until Sept. 18, 2007, at which time it lowered the rate by half a percentage point to 4.75 per cent during the financial crisis that year.

* In August 2007, because of signs of increasing stress in the financial system, the FOMC conducted two unscheduled meetings by conference call. At the second of those meetings, the Fed cut the discount rate to 5.75 per cent from 6.25 per cent.

* The easing cycle that began formally with the Sept. 18, 2007 reduction in the federal funds rate culminated with a final rate cut by the FOMC on Dec 16, 2008, when it took two important actions. It cut the federal funds rate from 1.0 per cent to the current level and set a target range of 0.00 per cent to 0.25 per cent for the daily federal funds rate, rather than a specific target rate.

* The Federal Reserve Bank of New York publishes the daily average, known as the federal funds effective rate, each day at around 1200 GMT (0800 New York time). Since the date of the last rate cut on Dec. 16, 2008, the daily effective rate has ranged from as low as 0.04 per cent to 0.25 per cent. It has averaged 0.129 percent during the period from Dec. 16, 2008, until now.

* The federal funds effective rate is currently 0.14 percent and has been at that level each day so far this month.

* The easing cycle incorporated more than interest rate cuts. It included a bond-buying program known as quantitative easing designed to flood the banking system with cash to foster private credit creation and to suppress long-term interest rates to keep borrowing costs low.

* Quantitative easing had three phases: QE1, QE2 and QE3. The QE1 cycle began in November 2008 and was expanded in March 2009. QE2 began in October 2010 and was augmented in September 2011 by "Operation Twist", in which the Fed reduced its holdings of shorter-term bonds and expanded its holdings of longer-term bonds. QE3 began in September 2012 and was expanded in December 2012. The tapering, or slowdown, of new purchases under QE3 was announced in December 2013 and was completed by October 2014.

* By the time the Fed was finished adding to its balance sheet, it had acquired $3.6 trillion of U.S. Treasuries and mortgage-backed securities over the three rounds of QE, and the balance sheet had grown to $4.47 trillion from about $850 billion. The balance sheet is roughly $4.44 trillion today.

Published on September 17, 2015
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