Question: How Does the Fed Cut Rates?
The Federal Reserve
cuts the Federal fund rate through the Federal Open Market Committee (FOMC
. Exactly how does the Fed influence the FOMC to cut the rate? The FOMC sets a target for the Fed funds rate
at its monthly meeting. This Federal interest rate
is charged for the Fed Funds
, which are loans made by banks to each other to meet the Fed reserve requirement. Technically, these rates are set by the banks themselves, not the Federal Reserve.
However, for the most part, these rates rarely vary from the target rate. This is because the banks know that the Fed will use its other tools, such as the reserve requirements, discount rate and reserve balance supply, to create pressure on the Fed funds rate to meet its target. These are some of the tools the Fed used to restore liquidity in the 2007 Banking Meltdown.