The Federal Open Market Committee decided today to lower its target for the federal funds rate 75 basis points to 2¼ percent.

Recent information indicates that the outlook for economic activity has weakened further. Growth in consumer spending has slowed and labor markets have softened. Financial markets remain under considerable stress, and the tightening of credit conditions and the deepening of the housing contraction are likely to weigh on economic growth over the next few quarters.

So read the beginning of a press release from the Federal Reserve issued on March 18, 2008. (A basis point is equal to 0.01 percentage point. So the statement implies that the Fed lowered the target from 3% to 2.25%.) We learned about the federal funds rate in Chapter 14: it’s the rate at which banks lend reserves to each other to meet the required reserve ratio. As the statement implies, at each of its eight-times-a-year meetings, a group called the Federal Open Market Committee sets a target value for the federal funds rate. It’s then up to Fed officials to achieve that target. This is done by the Open Market Desk at the Federal Reserve Bank of New York, which buys and sells short-term U.S. government debt, known as Treasury bills, to achieve that target.

As we’ve already seen, other short-term interest rates, such as the rates on CDs, move with the federal funds rate. So when the Fed reduced its target for the federal funds rate from 3% to 2.25% in March 2008, many other short-term interest rates also fell by about three-quarters of a percentage point.

How does the Fed go about achieving a target federal funds rate? And more to the point, how is the Fed able to affect interest rates at all?