E What It Would Have Meant If The Fed Had Raised In March

This article provides an impact assessment of the FOMC March 19-20 meeting and a possible rise in the Federal Funds Rate [FFR] to 2.75% at a future meeting sometime later this year.

The Federal Reserve held the target range for FFR at 2.25-2.5 percent during its first policy meeting on March 20, 2019, and reaffirmed its position to be patient about further policy firming in light of recent global economic and financial developments and muted inflation pressures.

The current FFR situation is shown in the chart below.

FFR rate

What Happens When The Fed Changes Rates?

A movement of the FFR has three broad impacts:

  1. Bank lending costs on required reserves.
  2. Interest burden on private debt.
  3. Interest on newly issued Treasury deposits.
  4. Interest paid on excess reserves, also known as the support rate.

These four impacts will be looked at in turn.

Bank Lending Costs

The stock of private debt is shown in the chart below as a percentage of GDP.


One sees the most current level of private debt-to-GDP is 202.8% for 2017.

The table below shows the impact of the rate hike on bank reserves advanced by the Fed, via the discount window, when a bank makes a loan.

Impact of FFR rise on bank lending costs

(Source: Author calculations based on Trading Economics GDP measure)

The next most likely level is shown highlighted in green.

Loans create deposits and generate reserves at the Fed. The Fed creates the reserves on demand as part of the federal payments system. If not able to access reserve funds from other commercial banks on the interbank market, a bank can always access reserves from the Fed at the FFR. The interbank rate is shown in the chart below and shows that at present commercial banks would be better off obtaining their required reserves from the Fed discount window at 2.5% rather than the current 2.6% interbank rate.


US interbank rate

Every 0.25% rate movement changes the cost of loan funds by $10 billion. The private banks then pass on this rate change to the customer if they can.

An FFR increase can be seen as a giant, economy-wide tax on borrowers and lenders. Each time the Fed raises 0.25%, it moves $10 billion from the private sector to the government sector.

The Fed is the national government's bank and remits its profits to the national government in the same way that taxes are remitted from the private sector to the government. The national government is the issuer of the dollar; it has as many dollars as it wishes to create, and does not need to get them from an outside source. The $10 billion income stream to the government from a Fed rate rise is deleted from existence in the same way as national taxes. It is a net reduction in the money supply. It exists on no measure of any money supply after remittance, not M1, M2 or M3. This is a contractionary and deflationary impact at the macro level.

Interest Burden On Private Debt

The following table shows the impact of the rate on the stock of private debt in absolute terms and as a percentage of GDP. The likely new FFR is highlighted in green.

FFR rise impact on consumers

The chart shows that with each 0.25% FFR rise, $98 billion, or 0.53% of GDP, is transferred from the household and business sector to the finance sector in a macro intersectoral income transfer.

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Alan Longbon 2 years ago Author's comment

You can view more of my work here seekingalpha.com/.../alan-longbon#regular_articles