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Ask Dave

The Meaning Of The Rate Cut

Dave explains to a caller how the fed funds rate factors into the economy, and what it affects.

QUESTION: Jeff knows that the federal rate cut today doesn’t affect some aspects of business and the economy. What does the federal funds rate affect, and would the free market be able to work itself out without it being messed with?

ANSWER: The fed funds rate is the rate at which the banks borrow from each other, typically just to cover cash flow overnight. The fed dropping that drops what banks pay for money, so their wholesale price for money went down. Any time a business pays less for what it sells, it could make more profit because it has less cost, or it will drop prices. The hope is that it would cause banks to do either

It only affects car loans or credit card rates to the extent that the bank chooses to pass savings onto the customer. Some banks will do that and others won’t. They don’t choose to lower credit card rates, for example; they just make the extra profit on that. It doesn’t affect mortgage rates because mortgage rates are established on the bond market. When the bond market goes up, interest rates go down.

When the fed lowers what banks pay, it doesn’t directly affect the bond market. There can be a perceived change in the marketplace of what interest rates are, so people might tend to think they will pay a little more for a bond, and that drives the rates down.

We’ll never know if the market will work itself out, because these goobers in Washington can’t keep their fingers out of it. The government has gotten involved with every layer of the market for the first time ever. I’d like to think it would work itself out, but the government is crummy at virtually everything they do except the military.