Fed Funds Rate Lowered to 4.75% - What Exactly Does It Mean?

Here is an excellent question that essentially asks what the Fed Funds rate action means.

I hope you can answer my questions because no one in the media seems to be addressing it. I really don't understand the consequences to the short term interest rates set by the Federal Reserve.

If rates go higher does that mean the government is taking in more money through higher interest rates. If they are pushed lower, as they were yesterday, does that mean the government is taking in less money? If rates go so low as they were a couple years ago, even below inflation, isn't the fed in some way subsidizing loans to borrowers? And who gets these loans? Do the banks get them and then pass them off to the consumer?

A lower Fed Funds rate will not substantially affect how much money the government takes in. That is because the Fed Funds rate is really a target rate for the overnight rate, which banks charge each other. Since the government does not really lose money, then it also does not subsidize any loans to borrowers via the Fed Funds rate.

By using the Fed Funds rate as a target, the banks are really the funding mechanism that you are talking about. Yes, a lower interest rate will cause the bank to make less money on that particular loan. However, lower interest rates make more loans affordable to more borrowers, so the banks make money by lending more. What they lose in a small margin of profit they make up through volume.

To understand more about how this works, read A Primer on Current Federal Reserve Interest Rates.