Neither will targeting the Federal Funds interest rate, no matter how the target is chosen.
The Fed should announce that it will let the federal funds interest rate float, at the same time removing some of the excess money it created in 2004--05.
With major bank stocks trading at below book value today, the deal offers some questions about the ability of lending institutions to find earnings value in the near term, with the federal funds interest rate still near zero.
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On Oct. 8, as part of an unprecedented global cut, the Fed dropped the overnight federal funds rate the interest rate at which banks lend to each other to 1.5 percent from 2 percent.
The second reason for likely interest rate increases can be attributed to the correlation between the Federal Funds Rate and bond interest rates.
"In practice, the federal funds rate has fallen somewhat below the interest rate on reserves in recent months, reflecting the very high volume of excess reserves, the inexperience of banks with the new regime and other factors, " he said.
That was the meaning of the announcement of the US Federal Reserve that it anticipates holding its official interest rate, the so-called federal funds rate, at exceptionally low levels "at least" through mid-2013.
The Fed said it was cutting the federal funds rate, the interest that banks charge each other on overnight loans, to 3.5 percent, down by three-fourths of a percentage point from 4.25 percent.
The Bernanke Fed has kept the interest rate on federal funds near zero since December 2008, and that rate is likely to persist until mid-2013, as announced at the latest meeting of the Federal Open Market Committee.
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But there is a huge difference between borrowing from the Fed at near zero interest rates and borrowing at that rate in the Federal Funds market.
Switching to a quantity of money target to get out from having to defend the high interest rates necessary to tighten money, Volcker allowed the federal funds rate to reach 20 percent for much of 1981.
The FOMC has its hands on only the shortest of short-term interest rates the overnight rate at which banks can borrow federal funds.
With the Federal Funds rate now at 2.5%, the Fed is effectively lending money at zero interest, based on August's 2.7% rate of inflation.
Interest rates on short-term loans do indeed tend to move in line with the federal-funds rate.
The virtue of these policies in the current context is that they allow the Federal Reserve to continue to push down interest rates and ease credit conditions in a range of markets, despite the fact that the federal funds rate is close to its zero lower bound.
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