I hope I don’t repeat myself too often in pointing out that the titles of this Financial Myths blog are, indeed, financial myths. Especially this one. All the Fed Fund rate is is the rate that the Federal Reserve suggests that banks charge each other for overnight loans to meet their reserve requirements. Financially sound banks can negotiate better terms amongst themselves. The rest can pay the set rate or, failing that, go to the Fed’s discount window.
For the sake of simplifying this, imagine that you and a friend each have a coffee cart. You’re on different corners so you don’t mind cooperating. One way you do that is if, at the end of the day you don’t have enough cofee to meet demand the following morning you can borrow from your friend, who may have coffee left over from today. Then when your suppliers open the next day you restock and also buy enough to pay your friend back. And vice versa. You agree to pay each other 0.1% of the value of the borrowed coffee for the overnight loan.
This has nothing to do with the prices you charge for your coffee! No relationship whatsoever. But suppose the public doesn’t know that. You meet with your friend and decide to double your loan rate to 0.2%. Then you both announce that your Coffee Beans Overnight Rate has doubled so you must also double your coffee prices. The public says, “Well, yes, that makes perfect sense”. But the fact is, you have not incurred any additional costs no matter how high you raise the Coffee Beans Overnight Rate because you borrow from, and pay, each other almost equally.
Banks and other financial institutions use the Fed Funds rate as an excuse to raise the cost of their money even though they had plenty to loan out at lower rates. It is merely one of many parts of the one-way wealth valve that has decimated the middle class and enriched the already enriched by removing virtually all connection between productivity and income. If the Fed were really interested in fulfilling its mission of Full Employment, it would inject funds directly into the economy, straight to individual human consumers.
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