STEVE INSKEEP, Host:
Welcome to the program.
M: It's good to be here.
INSKEEP: How does this work? The Fed funds rate is money loaned from one bank to another overnight. What does that have to do with the economy precisely?
M: Well, the way the Fed gets to influence the economy is that it can loan more or less money to banks. And by loaning more money to banks, it injects money into the financial system, and the price of loans is the interest rate. So when the Fed injects more money into the system, it essentially lowers interest rates, and it lowers the interest rate that banks charge each other. And once that comes down, the interest rate on all sorts of other things comes down, like the interest rate on car loans or credit cards.
INSKEEP: Why do banks make overnight loans to each other?
M: Well, the way the financial system works, there's money moving around all the time, so banks are constantly lending money, not only to consumers but also to each other in order to shore up positions or move money around to different investments. This will increase economic activity. Fed interest rate cuts take some number of months to wash through the economy, typically six to nine.
INSKEEP: So banks have a little easier time loaning money to each other. Is it that banks don't trust their other banks to pay the loans back or is it they don't actually have money to lend?
M: The fundamental problem we're facing here is not some sort of short-term loss of confidence or short-term loss of liquidity as much as it is the fundamental problem of we need to work ourselves out of this huge housing bubble. And so while the Fed can mitigate the downturn somewhat, either keeping us out of recession or more likely making the recession that's coming less deep, it can't solve the fundamental problem. The Fed can't make the housing bubble go away.
INSKEEP: David Leonhardt of the New York Times. Good talking with you.
M: Thanks for having me.