Options for modernizing the FOMC’s operating target interest rate

Options for modernizing the FOMC's operating target interest rate

The Federal Open Market Committee (FOMC) primarily adjusts the stance of monetary policy by changing the target range for the federal funds rate. Each of the FOMC's post-meeting statements, for almost as long as the FOMC has issued post-meeting statements, has reported what the Committee decided about the fed funds target and how the Committee intended that action to advance its statutorily mandated goals of maximum employment and price stability. The FOMC has repeatedly affirmed the centrality of the fed funds target in establishing its policy stance, most recently in the August 2025 revision of its "Statement on Longer-Run Goals and Monetary Policy Strategy."[1]

The fed funds target is an operating target: a measure of monetary conditions that the Federal Reserve directly influences from day to day as it implements its strategy for achieving broader and longer-run economic goals. This essay questions whether the fed funds rate remains the right operating target for short-term interest rates.

To be clear, we assume the FOMC will continue to pursue the monetary policy strategy it described in the August 2025 statement, including the 2 percent inflation target and the balanced approach to the price stability and employment objectives. The operating target specifies only how the FOMC measures and influences monetary conditions; it is distinct from the question of how restrictive or accommodative those conditions should be to achieve the FOMC's macroeconomic goals. We also assume the FOMC would continue to adjust the stance of policy primarily through a short-term interest rate or rates, just not necessarily the fed funds rate.

We make four points:

First, the Fed has repeatedly evolved its operating targets to maintain influence over monetary conditions as the financial system evolved. Updating the target again to reflect how the financial system has changed in the decades since the FOMC began targeting the fed funds rate would continue that longstanding practice.

Second, money markets have changed greatly since the FOMC began publicly targeting the fed funds rate in the mid-1990s. Fed funds is a market for uncollateralized overnight bank funding. Uncollateralized interbank loans are far less important to the financial system than they once were, overtaken by collateralized, or secured, financing.

Third, while the fed funds target continues to give the FOMC effective control of broader monetary conditions, connections between the fed funds market and broader money markets have grown fragile. If fed funds were to disconnect from broader money markets, the FOMC could need to rapidly adopt a new operating target. We argue that instead of waiting for an urgent need, the FOMC should change proactively and planfully to a different target rate.

Fourth, the cost of proactively switching to a different operating target is not high. Other rates are readily available, particularly repo reference rates, that would provide more robust targets than fed funds. Because fed funds is currently well connected to other rates, targeting a different rate need not disrupt monetary policy communications or money market conditions. By maintaining a target range and allowing the target rate to fluctuate within a band, the Fed can target a repo rate without large, frequent and complex market interventions. Changing proactively would reduce the risk of having to adopt a new target during a period of economic or market stress. A proactive move would also allow the FOMC to announce the transition well in advance so market participants could prepare.

The essay proceeds as follows. Section 1 gives a brief history of the Fed's operating targets, showing how they have changed in response to the evolution of the financial system. Section 2 reviews how money markets have changed since the mid-1990s, making the fed funds market more idiosyncratic than it was when the FOMC adopted the public fed funds rate target. Section 3 discusses the fragility of the fed funds market's connections to broader money markets. Section 4 evaluates options for alternative operating targets and argues for the merits of targeting a Treasury repo rate such as the tri-party general collateral rate (TGCR). Section 5 assesses the benefits and costs of proactively transitioning to an alternative operating target relative to preparing a contingency plan but not yet implementing it or to taking no action. Section 6 concludes.

1. A brief history of the Fed's operating targets

Since its inception, the Federal Reserve System has sought to influence monetary conditions in order to promote the macroeconomic outcomes that policymakers desire. Policymakers decide whether to make monetary conditions tighter or looser or leave conditions unchanged and then direct actions-such as open market operations by the Open Market Trading Desk at the Federal Reserve Bank of New York-to produce that result. However, a vague goal of influencing general monetary conditions is not precise enough to design the necessary operations. The Fed needs a specific, quantitative target so it can determine what specific operations would have the desired effect. Beyond this operational role, since the mid-1990s, the target has had a second role: to transparently communicate the stance of monetary policy to the public and allow the public to hold the FOMC accountable for its choices.

Over the years, the Fed has employed a variety of operating targets, adapting to changes in the economic and financial environment. In reviewing that history, we draw heavily on a book by retired New York Fed officer Ann-Marie Meulendyke.[2]

During the first and second World Wars, the Fed sought to support the nation's war financing needs, rather than the typical peacetime goals of employment and price stability. As a result of these different goals, the Fed also had different operating targets during these periods, aimed at holding down longer-term interest rates on Treasury securities.

Following World War II, the 1951 Fed-Treasury accord allowed the FOMC to focus on controlling inflation and stabilizing the macroeconomy.[3] At that time, bank reserve requirements had a binding influence on bank lending and, in turn, on economic activity. Free reserves consist of commercial banks' total reserves minus those borrowed from the Fed's discount window or required to meet regulatory requirements. A higher level of free reserves gave the banking system more capacity to lend and represented easier monetary policy. Accordingly, in setting an operating target for monetary policy, the FOMC and the Open Market Trading Desk sought to control the banking system's free reserves.

In the 1960s, changes in the economy and financial system led the FOMC to consider a wider set of monetary indicators. Meulendyke reports that studies at the time suggested money growth, total reserves, discount window borrowings or the monetary base might affect macroeconomic outcomes more predictably than free reserves. In addition, there was growing activity in the fed funds market, which made the fed funds rate an increasingly useful indicator of monetary conditions. By 1967, daily open market operations sought to control the amount of borrowed reserves as well as keep the fed funds rate in a desired range.[4]

Importantly, the FOMC in this era did not publicize a fed funds rate target. Market participants had to infer what it was from the Desk's actions in open market operations. The fed funds rate was a target that guided operations but not yet a communications vehicle.

Through the 1970s, the FOMC gradually increased its focus on the fed funds rate as the primary operating target. There were also targets for monetary growth, but while the Fed was able during this period to tightly control the fed funds rate, it frequently overshot its targets for monetary aggregates.

By the late 1970s, policymakers thought the Fed needed to tightly control monetary aggregates to bring down then-soaring inflation. The Fed moved to targeting rates of reserve growth that would produce the desired paths of M1 (consisting at the time of currency in circulation and demand deposits) and M2 (M1 plus savings deposits and certain time deposits). The fed funds rate could swing by as much as several hundred basis points in a day, as long as monetary aggregates remained under control.

In the early 1980s, though, the relationship between economic activity and monetary aggregates became unstable as banks created new types of interest-bearing accounts and lawmakers phased out caps on savings interest rates.[5] The resulting shifts in demand for bank deposits meant it was no longer clear how to target monetary aggregates to produce desired macroeconomic outcomes. The FOMC reverted to targeting borrowed reserves. The Desk monitored the behavior of the fed funds rate to assess whether it needed to add or drain reserves to hit the target for borrowed reserves.

The next important change was initially one of communication rather than targeting. In the mid-1990s, responding to a need for greater public transparency, the FOMC began issuing press releases announcing its policy decisions. This change meant market participants and the public no longer needed to infer the FOMC's decisions from Desk operations and from minutes released weeks after a meeting. The first post-FOMC press release, issued Feb. 4, 1994, was concise. It did not discuss the economic outlook or policy strategy in detail, nor did it mention a quantitative target for the fed funds rate. The statement began: "Chairman Alan Greenspan announced today that the Federal Open Market Committee decided to increase slightly the degree of pressure on reserve positions. The action is expected to be associated with a small increase in short-term money market interest rates."[6] It was not until July 1995 that the FOMC began announcing a quantitative target for the fed funds rate.[7] Even then, the Committee continued to describe the movement of the fed funds rate as the expected result of a change in "pressure on bank reserve positions" rather than as a first-order operating target. Finally, in January 1996, the FOMC moved to the present practice of announcing only the fed funds rate target and not intended pressures on reserve positions.[8]

2. Changes in money markets since the mid-1990s

The fed funds market is a marketplace for unsecured loans between banks or other institutions that are eligible to hold deposits at a Federal Reserve Bank. Besides commercial banks and credit unions, institutions eligible to hold these deposits and, thus, trade in fed funds include government-sponsored enterprises (GSEs) such as the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corp. (Freddie Mac) and the Federal Home Loan Banks (FHLBs).

The fed funds rate is the average rate on overnight loans in the fed funds market. Computing an average requires methodological choices such as which data sources to include, how to treat transactions at extreme rates, and whether to compute a mean or a median. Since 2016, the New York Fed has published the daily effective federal funds rate (EFFR) as the volume-weighted median of interest rates on fed funds transactions that depository institutions list on a mandatory daily report.[9] Other data sources and methods were used previously. The current methodology is intended to capture a large base of transactions, mitigate potential vulnerabilities in the calculation process and align with international best practices for reference rates.[10] These characteristics help ensure that the FOMC's target rate accurately reflects actual conditions in the fed funds market.

In the mid-1990s, the fed funds market served a central role in setting banks' marginal cost of funds. That role made the fed funds rate well suited as a guide to overall money market conditions, both for shaping the Fed's operations and for communicating to the public.

Incentives on both the lending and borrowing sides of the market supported this role. Bank reserves at the time did not pay interest, while overnight market rates were typically hundreds of basis points above zero. That spread motivated banks with excess reserves to lend them to peers that were short of required reserves. Banks' incentives fostered a vibrant unsecured interbank market where the interest rate closely reflected banks' marginal cost of funds. Because banks could also borrow unsecured from prime money market funds and Eurodollar investors, that cost of funds was also well connected in the 1990s to overnight rates across the financial system, making fed funds a good indicator of and transmission path to monetary conditions overall.

But the market structure has changed. New regulations have disincentivized unsecured interbank borrowing and lending as well as unsecured lending by money market funds to banks. The Fed has begun paying interest on reserves and transitioned to a much more efficient operating regime with ample rather than scarce bank reserves. All these changes make the fed funds market less relevant to monetary conditions.

Changes in bank regulation since the Global Financial Crisis (GFC) have also weighed on fed funds activity. The GFC revealed many systemic vulnerabilities. Among them, unsecured interbank lending can amplify a crisis because of risks on both sides of the transaction. A bank that makes an unsecured loan to another bank is at risk of losing its money if the borrowing bank fails-and could then transmit the borrower's failure to the broader financial system. A bank that borrows unsecured funds on a short-term basis is at risk of being unable to roll over that funding if its creditworthiness deteriorates or the lender pulls back, and without collateral, it may have limited alternative options for funding.

Post-GFC regulations seek to mitigate these risks. On the lender's side, capital regulations call for banks to hold more capital to back unsecured loans to other banks.[11] Similarly, the Net Stable Funding Ratio requires large banks to issue more capital or long-term debt to back unsecured interbank loans. Secured lending against Treasury securities as collateral does not incur these costs. On the borrower's side, borrowing fed funds from FHLBs is treated more favorably than unsecured short-term borrowing from another commercial bank and can improve a large bank's Liquidity Coverage Ratio (LCR), while short-term borrowing against Treasury collateral does not affect the LCR. In addition, for firms designated as globally systemically important banks (GSIBs), one formula for calculating capital surcharges puts greater weight on unsecured funding from other financial institutions than on secured funding. Research has found that, in combination, these regulations make it less attractive for banks to lend fed funds or to borrow fed funds from other banks rather than from the FHLBs.[12]

Additionally, in 2016, the Securities and Exchange Commission (SEC) implemented new regulations to mitigate prime money market funds' vulnerability to runs. These regulations motivated a large shift of money market fund investments to government funds, which can buy short-dated Treasury securities and FHLB debt or make secured loans collateralized by Treasuries but cannot invest in unsecured bank debt.[13] Again, activity shifted away from unsecured interbank funding, and toward secured markets.

Improvements in monetary policy implementation have compounded this shift. Before the GFC, the Fed implemented monetary policy by keeping reserve supply below the quantity banks wanted to hold, and fine-tuning the supply of reserves to move up and down banks' aggregate demand curve. This artificial scarcity meant banks were pressed to economize on reserves, even though reserves are the safest and most liquid asset in the financial system.

In 2008, the Fed received authorization from Congress to begin paying interest on reserves. Paying interest on reserves makes it possible to supply as many reserves as banks demand with market rates close to interest on reserves, instead of controlling money market rates through scarcity. Since 2008, the Fed has operated in a regime of at least ample reserves, initially as part of actions to address the GFC and, since 2019, as a permanent operating framework.

The ample reserves regime enhances the stability and efficiency of the financial and payments systems by removing unneeded incentives for banks to economize on liquidity.[14] However, because supplying ample reserves keeps market rates close to interest on reserves, banks with excess reserves have little incentive to lend them out. Fed funds lending now comes mainly from a different source. Depository institutions can earn interest on reserves, but by law, GSEs cannot. The fed funds market has thus changed from one that redistributed scarce reserves and set banks' marginal cost of funds to one where GSEs and banks primarily arbitrage access to the interest rate on reserve balances (IORB). Today, instead of mainly reflecting banks' marginal cost of and need for funds, the fed funds rate also reflects the relative bargaining power between banks and GSEs, as well as banks' costs of expanding their balance sheets to conduct the arbitrage.[15]

Putting these changes together, the fed funds market is significantly less central to the financial system than it was in the mid-1990s. FHLBs make the vast majority of fed funds loans. Branches and agencies of foreign banks dominate fed funds borrowing, because these firms generally do not have deposit insurance and therefore have lower balance sheet costs for IORB arbitrage.[16] Fed funds loans that redistribute funds between domestic banks are uncommon.

Instead, the center of gravity in U.S. money markets today lies in secured markets-specifically, repurchase agreement (repo) markets, where participants trade overnight or short-term loans collateralized by Treasury and other securities. Chart 1 displays trading volumes in several money markets. Fed funds volume runs a bit over $100 billion a day. The daily volume captured in the broader Overnight Bank Funding Rate, which includes fed funds as well as certain other unsecured wholesale bank funding, reached $300 billion earlier this year but recently fell below $200 billion. In contrast, overnight and open-dated volume in repo markets exceeds $4.5 trillion on a typical day.[17] Unlike fed funds, repo rates represent both a marginal cost of funds for a wide swathe of borrowers that are intermediating investments to the real economy and a marginal investment opportunity for a wide set of lenders that have excess cash.

The private sector has also recognized the increasing importance of secured markets relative to unsecured markets in the United States. Beginning in 2013, government authorities and market participants worked to phase out the use of the London Interbank Offered Rate (LIBOR) as a reference rate in U.S. markets in response to vulnerabilities identified in LIBOR calculations. The Federal Reserve Board and New York Fed convened a group of private-sector participants as the Alternative Reference Rates Committee (ARRC) to select a replacement and foster a successful transition. LIBOR had been intended to estimate the interest rates that large banks would pay if they borrowed unsecured from other banks. The ARRC considered a range of unsecured and secured rates as potential replacements.[18] The ARRC's voting members represented banks and dealers, and the committee sought input from a wide set of market participants. In 2017, the ARRC announced that it had selected a broad U.S. Treasury repo rate in light of factors including the repo market's depth and robustness and the rate's usefulness to market participants, as well as the robustness of the rate's calculation.[19] By 2023, U.S. markets fully discontinued the use of LIBOR and replaced it with the Secured Overnight Financing Rate (SOFR).

3. The fragility of transmission between fed funds and other markets

The U.S. financial system is multifaceted. Market participants source funding across multiple markets. For any one interest rate to serve effectively as an operating target in this environment, the target rate needs to be sufficiently closely connected to other money market rates that it moves when other rates move and vice versa. It must behave this way across a wide range of economic and market scenarios, including both normal times and stress episodes. Otherwise, the rate would not provide a robust measure of broad monetary conditions or a robust way for the FOMC to influence broad monetary conditions. Previous Federal Reserve reviews of potential target rates have assessed the connections between candidate target rates and broader money markets under the rubric of transmission.[20] (Section 4 discusses other characteristics relevant to the selection of a target.)

The fed funds rate currently remains a viable operating target, because it remains well connected to broader money markets. Banks and GSEs active in fed funds are also generally active in repo and other money markets, so rates transmit well between fed funds and other markets. Chart 2 shows the comovement between interest rates across fed funds, broader unsecured bank funding markets as measured by the overnight bank funding rate (OBFR) and Treasury repo markets.

These connections have supported the FOMC's ability to continue targeting fed funds during both normal times and stress episodes even as market structures changed. The FOMC's tools have been effective both in controlling the fed funds rate and, through the fed funds rate, in influencing monetary conditions in general.

However, the connections between fed funds and other markets are imperfect and fragile.

The fed funds rate is noticeably less volatile than Treasury repo rates (Chart 3). Thus, fed funds already does not reflect all the changes that happen in monetary conditions. Money market developments in the first half of September 2025 provide an instructive example. (This essay reflects data through Sept. 16.)

In the first week of September, the tri-party general collateral rate (TGCR) rose by 3 to 7 basis points relative to the end of August, and SOFR rose by 5 to 8 basis points, as market participants digested a large net settlement of new Treasury securities. Repo rates partly retraced in the second week of September. Then, on Sept. 15, a tax payment date drained reserves at the same time as another Treasury settlement took place. TGCR rose 10 basis points that day to 4.50 percent, or 17 basis points above its level at the end of August, while SOFR reached 4.51 percent, also 17 basis points above its late-August level. The following day, repo rates retraced again. Yet throughout this period, EFFR remained at precisely 4.33 percent, exactly where it had been not just since August but, in fact, since the last change in the fed funds target range, on Dec. 19, 2024

The lack of movement in the fed funds rate does not directly follow from the FOMC's efforts to target it. The target range is 25 basis points wide, reflecting the FOMC's tolerance for meaningful fluctuations. Rather, discussions with market participants suggest that the stability results in large part from market concentration. The only major lenders in fed funds are the 11 FHLBs. (Other GSEs have withdrawn from the market.) The set of bank borrowers in fed funds is larger, but also concentrated, because balance sheet costs make IORB arbitrage unattractive for some banks and because investors limit their unsecured lending to very creditworthy names. In this concentrated environment, fed funds trading relationships are typically durable. Participants bargain over how to divide the pie on average over time, not how to respond to each day's minor fluctuations, and must weigh the value of the long-term relationship against any potential profits from a minor improvement in one day's rate.

Concentration makes the fed funds market, and its connections to other markets, fragile. The FHLBs have been exploring options for increasing their investments in deposit accounts at banks.[21] Recently introduced early morning maturity tri-party repo products could also attract FHLBs. Early maturity repos return cash earlier in the day than traditional tri-party repos, allowing the cash investor to meet more outgoing payments.[22] Payments timing has historically been an important component of FHLBs' liquidity management. Increased access to alternatives could reduce FHLBs' fed funds investments. And with only 11 FHLBs, any change in activity could quickly reach the entire market, not diffuse gradually as is often the case in less concentrated markets.

The fed funds market is also vulnerable to any stress that could lead the FHLBs to pull back on fed funds lending. For example, when regional banking stresses in March 2023 drove commercial banks to seek more term advances from FHLBs, the FHLBs appeared to meet those demands in part by reducing their fed funds investments. Fed funds volume fell from $115 billion to $41 billion in two business days, as illustrated in Chart 4. While volume quickly rebounded as the acute banking difficulties resolved, a longer-lasting stress episode could have reduced fed funds activity more persistently.

The fragilities in the fed funds market, if realized, could impede monetary policy implementation and transmission in two distinct ways. One risk is that fed funds activity could diminish to the degree that the fed funds rate was not measurable or did not reflect a meaningful volume of transactions. Separately, if participants became less willing to intermediate between fed funds and other markets, pricing on fed funds transactions could become disconnected from pricing in other money markets, even if fed funds volume remained meaningful. In either case, the fed funds rate would lose its usefulness as a gauge of and means to influence broader monetary conditions.

We do not think it would make sense to seek to revive the primacy of the fed funds rate by unwinding the structural changes that moved activity away from fed funds and weakened its connections to other markets. Ample reserves and the regulations that promoted a shift toward secured funding markets have improved the financial system's efficiency and resiliency . Reversing those changes so that the fed funds rate could remain the best operating target would be a case of the tail wagging the dog.

4. Alternative options for the operating target

In 2016 and again in 2018, Federal Reserve staff reviewed options for changing the target rate.[23] These reviews considered three broad categories of alternatives:

• An administered rate, such as the interest rate on reserve balances, the primary credit interest rate at the discount window or the rate on the Fed's overnight reverse repo (ON RRP) facility.
• Measures of the constellation of money market rates, such as an average across several rates or a more qualitative reference to the general level of rates.
• A single market rate, either fed funds or a different rate.

(We focus on interest rates as potential operating targets. Historically, as section 1 discussed, the FOMC has sometimes targeted quantities rather than prices. However, in the FOMC's current ample reserves implementation regime, targets involving monetary aggregates or reserve supply would not transmit effectively or in predictable ways to financial conditions and the economy.)

Other major central banks' operating targets also fall into these categories. The Bank of England's operating target is an administered rate, Bank Rate, which is the interest rate paid on bank deposits at the central bank and governs the interest rate on lending facilities.[24] The European Central Bank expresses its policy decisions in terms of three administered rates, one for a deposit facility and two for lending facilities. The Bank of Canada announces a policy target rate and measures achievement of this target primarily by movements in the Canadian Overnight Repo Rate Average (CORRA), a market rate for repos collateralized by Canadian government debt. The Reserve Bank of Australia sets a target for the cash rate, which is an interest rate on unsecured overnight interbank loans. And the Swiss National Bank aims to keep a constellation of secured short-term money market rates close to its policy target.

In this section, we assess potential targets from these categories against four criteria drawn from previous reviews. Transmission to broader money markets is a central criterion, for the reasons discussed in section 3. Additionally, the target rate must be controllable either with the FOMC's existing tools or with tools that the FOMC could develop; otherwise, the FOMC would have no way to implement its policy decisions. The target rate also features prominently in the FOMC's communications. International experience and previous Fed analyses indicate that a very wide range of potential targets can allow a central bank to clearly communicate the stance of policy. A more challenging aspect of communications, to which we devote more inquiry, is public accountability. Announcing the setting of the target should allow the public to compare the announced target with actual money market conditions and verify that the FOMC is carrying out the monetary policy stance that it announces. Finally, we consider how potential targets might interact with the Federal Reserve System's federated governance structure, which includes the FOMC, the Board of Governors and the 12 Reserve Banks.

Administered rates

The effectiveness of transmission may vary across administered rates and could depend on how the FOMC manages the Fed's balance sheet. In the Fed's current implementation regime, ample reserve supply fosters efficient arbitrage between rates paid on balances held at the Fed, such as IORB or the rate on the ON RRP facility, and broad money market rates. Because reserves are currently more than ample, activity has been low at lending and funding facilities such as the discount window and Standing Repo Facility (SRF), making it less clear how well rates on those facilities might transmit across money markets. If the FOMC reduced reserve balances to the point that such facilities saw more active use, as some other central banks have done, there could be more confidence in the transmission of administered lending rates.[25]

However, treating an administered rate as the operating target would short-circuit the FOMC's accountability for implementing the monetary conditions it claims to target. The administered rate would, by definition, always be on target. But that is not the right measure of successful implementation. If the FOMC did not say what conditions it aimed to achieve in money markets, the public would have no way to check whether monetary policy operations were having the intended effect on those market conditions.

Targeting an administered rate would also create challenges for governance. Different parts of the Federal Reserve System set different administered rates. The FOMC chooses rates on the SRF and the ON RRP facility, both of which rely on the Committee's authority to direct open market operations under section 12A of the Federal Reserve Act. The Board of Governors sets IORB. And the boards of directors of the 12 Reserve Banks establish the primary credit rate at the discount window, subject to review and determination by the Board of Governors.

When the FOMC targets a market rate or rates, all those governance bodies are responsible for adjusting their respective administered rates appropriately to help achieve the target. By contrast, if the Fed directly targeted an administered rate, whichever part of the Federal Reserve System controlled that rate would become preeminent. Such a change would weaken the Fed's federated governance, which itself provides important accountability and connection to the public.[26]

A constellation of rates

Targeting the constellation of market rates would create challenges for accountability. If the FOMC wanted to quantitatively target a basket of rates, it would need to determine which rates to include in the basket and how to express the target, such as whether to put more weight on some rates than on others, and how to treat divergences between rates. One possibility would be a volume-weighted mean of key money market rates. However, there are also arguments for weighting rates by factors other than volume, such as the degree to which they are representative of broad funding conditions and not potentially distorted by idiosyncratic factors, or for aiming to keep each separate rate within the target range. These technical questions about how to express the target could distract from communications or lead to debates about what yardstick to use to hold the FOMC accountable.

Alternatively, the FOMC could state qualitatively that it was targeting the general level of overnight or short-term rates. Yet without a quantitative target, the public would have difficulty holding the FOMC accountable for hitting the target. So, although monetary policy needs to influence money market rates broadly, we believe it is more practical to target a single, carefully chosen rate that is well connected to others.

Alternative single interest rates

A relatively modest step to address the fragilities of fed funds would be to target a more robust rate that still measures unsecured bank funding costs. The overnight bank funding rate (OBFR) is the primary option of this type. As Chart 1 shows, OBFR covers several times as much trading volume as the fed funds rate, primarily because OBFR includes loans to banks from institutions that are ineligible to hold reserves, such as non-bank financial institutions or non-financial corporations. The breadth of this market means that transmission between OBFR and other rates is good, and the Fed's policy implementation tools effectively control OBFR, which usually remains close to EFFR. Thus, OBFR would provide effective transmission and control, and previous Fed staff analyses of potential target rates have considered it as a potential option.

The main drawback to OBFR is that the bulk of U.S. money market activity takes place in secured rather than unsecured markets. Targeting OBFR requires relying on transmission from unsecured bank funding to repo markets. That transmission could weaken if financial stresses or other developments create frictions in markets, or if banks further reduce their use of unsecured funding. Directly targeting a repo rate would provide stronger assurance of transmission to the core of U.S. money markets because the FOMC would be directly targeting a rate in that core.

Participants in repo markets borrow and lend against a range of collateral, including Treasury securities, mortgage-backed securities and other securities. Because of the safety and liquidity of the collateral, Treasury repos are essentially risk-free when participants follow best practices for risk management.[27] In consequence, repo rates against Treasury collateral form the baseline against which other repo rates are measured.

The risk-free nature of Treasury repo rates provides an additional advantage. Ordinarily, risk premiums in overnight money markets are small. However, in stress episodes, risk premiums can rise and push unsecured bank funding rates meaningfully above risk-free rates. Targeting an unsecured rate would commit the Fed to automatically offset such a change in risk premiums, at least if the change were sufficiently large. While changes in risk premiums can certainly influence the appropriate stance of monetary policy, the relationship is not formulaic and depends on risk premiums across many markets and tenors.[28] For this reason, it is preferable to target a risk-free rate that underpins monetary and financial conditions broadly and allow policymakers to separately consider whether changes in risk premiums-whether in unsecured bank funding or in other markets-motivate an adjustment to the policy stance.

Treasury repo markets include a broad set of participants that are also active in and able to move funding to and from other repo markets as well as to and from funding markets other than repo. Thus, a Treasury repo rate will transmit effectively to and from broader monetary conditions. Moreover, due to their safety, Treasury repo markets have historically functioned smoothly even in many stress episodes that disrupted other markets. No market can be guaranteed to function well in all circumstances, and there have been episodes of stress in Treasury repo. However, Treasury repo is likely to maintain transmission across a wider range of scenarios than other, less resilient markets.

Before assessing whether the FOMC can control a Treasury repo rate, it is useful to define the target rate more precisely. The New York Fed publishes three overnight Treasury repo reference rates:

• The tri-party general collateral rate (TGCR) covers transactions on the Bank of New York Mellon's tri-party platform. This platform mainly connects large cash investors such as money market funds with large securities dealers.
• The broad general collateral rate (BGCR) includes the transactions in TGCR as well as a small slice of centrally cleared transactions in what is known as the GCF Repo Service.
• The broadest reference rate, the Secured Overnight Financing Rate (SOFR), includes the TGCR and BGCR transactions, plus a large set of repos that are centrally cleared at the Fixed Income Clearing Corp. (FICC). The latter transactions mainly move funding from large dealers to small dealers and leveraged investors.

For practical purposes, BGCR and TGCR are currently very similar, so we focus on the tradeoffs between SOFR and TGCR as potential operating targets. Both SOFR and TGCR are market-based reference rates calculated and published with robust methodology. But the different transactions they include offer different combinations of benefits and costs as an operating target. Importantly, the structure of the repo market is evolving as market participants implement the SEC's mandate to centrally clear a broader set of Treasury repo transactions by June 30, 2027.[29] We compare SOFR and TGCR under the current structure and then consider how implementation of the clearing mandate could affect each rate.

Participants in dollar funding markets have widely adopted SOFR as a reference rate following the wind-down of LIBOR, as recommended by the Alternative Reference Rates Committee.[30] Among available repo reference rates, SOFR also covers the widest set of overnight Treasury repo transactions, currently more than $2.5 trillion a day. These characteristics support SOFR's transmission to broad monetary conditions.

However, in the market's current structure, SOFR does not represent a clean gauge of the cost of liquidity. SOFR combines two distinct market segments: tri-party repos primarily between large cash investors and large dealers and centrally cleared repos primarily between large dealers and smaller ones or leveraged investors. The combination of multiple market segments means that the distribution of rates on SOFR transactions can have multiple peaks. The published SOFR rate, which is the median of reported transactions, has the potential to fall in between the modes, at a thin part of the distribution where fewer transactions occur. Large dealers also have some market power in intermediating between the two segments.[31] Rates in the centrally cleared segment can partly reflect that market power rather than a clean reading on the cost of funds. Fluctuations in market power could cause fluctuations in SOFR that would not relate to broad monetary conditions or how those conditions influence the economy. Movements in the target rate unrelated to broad monetary conditions could complicate the FOMC's communications, and the Committee could judge that monetary policy should not aim to control the returns to market intermediation.

TGCR is not currently subject to the same drawbacks. Although TGCR covers a narrower set of transactions than SOFR, it incorporates more than $1 trillion in daily volume. These are risk-free, overnight transactions that represent a marginal cost of funds and marginal return on investment for a wide range of borrowers. Broad participation in tri-party repo also keeps TGCR well connected to other money markets and robust to changes in the behavior of small groups of participants.

Implementation of the clearing mandate could change the market structure in ways that would affect the relative strengths and weaknesses of SOFR and TGCR. The clearing mandate will likely increase volume in SOFR's cleared segment. Broader central clearing also has the potential to make SOFR more robust by strengthening connections between repo market segments. On the other hand, other clearinghouses intend to compete with FICC to clear Treasury repos. If those services attracted significant market share, it could be necessary to consider a different target rate or revise the definition of SOFR. Similarly, the transition to broader central clearing has the potential to move activity away from the tri-party market that TGCR measures, but tri-party activity would remain robust if market participants choose to clear tri-party transactions.

Although the FOMC currently targets the fed funds rate, in practice its existing tools already effectively control TGCR as well. Chart 5 shows the fed funds rate and TGCR relative to the fed funds target range since April 2018, when the New York Fed began publishing repo reference rates. TGCR fell within the target range on all but 50 of the 1,864 publication dates in the sample (through mid-September 2025). The last excursion outside the target range was in 2022, and changes in policy implementation since then significantly reduce the likelihood of a recurrence.

All dates when TGCR exceeded the top of the target range occurred in 2020 or earlier. Since then, the FOMC has established the Standing Repo Facility (SRF), which strengthens the ceiling on both the fed funds rate and TGCR by offering funds in tri-party repo at a rate equal to the top of the target range. Technical adjustments of the position of administered rates in the target range could also be used to help keep TGCR in the target range over time. In particular, at an efficient level of reserves, we expect money market rates to average close to IORB, with fluctuations higher and lower. IORB is currently set closer to the top of the target range than to the bottom. Positioning IORB at the center of the range could reduce the likelihood of peaks exceeding the top of the range.

The FOMC and Desk have also developed additional tools for monitoring reserve supply and ensuring reserves remain above the minimum level needed for the ample reserves regime. These monitoring tools reduce the risk of a sharp drop in reserve supply that could produce a spike in repo rates like that seen in September 2019.

When TGCR fell below the target range, it was never by more than 5 basis points. These occurrences came almost entirely in 2022, when extremely abundant reserve supply pushed repo rates well below interest on reserves. They are not likely to be repeated if, as planned, the FOMC maintains reserve supply at an ample level, which, in our view, would produce market rates close to rather than meaningfully below interest on reserves.

SOFR might be less controllable than TGCR with current tools, though a plausible enhancement to the tools could support the ability to control SOFR. The Fed conducts its open-market repo operations on the tri-party platform, directly influencing conditions in the market where TGCR is measured. Conditions in the cleared segment of SOFR depend on how the Fed's repo counterparties, such as primary dealers, and other tri-party participants intermediate funding to broader money markets. As previously noted, dealers have some market power in this intermediation. Additionally, dealers face balance sheet costs of intermediating between market segments because funds borrowed in tri-party repo cannot be netted against funds lent in centrally cleared repo for all purposes.

The SEC's mandate for broader central clearing does not apply to the Fed, but the Fed could choose to clear its transactions on a voluntary basis, and some FOMC participants have suggested that the Fed consider doing so.[32] Centrally cleared open market operations would both allow the Fed to more directly influence conditions in the cleared segment and reduce Fed counterparties' costs of intermediating to that segment. Such a change would enhance the Fed's ability to provide liquidity to markets in stress episodes that can disrupt intermediation and its ability to influence money market rates in general. It would also specifically enhance the ability to control SOFR.

The greater volatility of Treasury repo rates relative to fed funds arises in part from periodic large fluctuations in the amount of collateral and funding available in repo markets. These fluctuations include flows on dates when the Treasury Department settles auctions of new securities and maturities of existing ones, as well as dynamics associated with payment dates on mortgage-backed securities and with foreign banks' management of their balance sheets around statement dates such as month-ends and fiscal year-ends.

We do not think targeting a Treasury repo rate would require the Fed to reduce its volatility to the level currently observed with fed funds and offset these large fluctuations.[33] The FOMC's target range for fed funds is 25 basis points wide, implying a tolerance for day-to-day rate fluctuations. Despite Treasury repo's centrality to money markets, the existing level of volatility in Treasury repo rates has not appeared to pose any challenges to the transmission of financial conditions across markets or financial stability. Targeting a Treasury repo rate in a way that maintained the current level of volatility appears likely, therefore, to be effective from a policy perspective. Allowing this amount of volatility would also limit the risk of conducting large open market operations simultaneously with Treasury settlements that could be misperceived as interacting with fiscal policy. It would be necessary, though, to communicate that the FOMC would tolerate fluctuations in the target rate within the target range, similar, for example, to those observed today with TGCR but larger than those currently observed with the fed funds rate.

5. Benefits and costs of proactively changing the operating target

The fragility of the FOMC's current operating target presents a tradeoff. Proactively moving to a different target would mitigate the risk to policy implementation from fragilities in fed funds. However, moving to a different target would also require the FOMC to incur costs of making the transition without any certainty about when or whether fed funds would cease to be a viable target. Taking no action would avoid incurring transition costs for now. However, it would pose the risk of a rapid change to a new target under urgent conditions should fed funds suddenly disconnect from other markets. An intermediate course of action would be to prepare and communicate a contingency plan for transition but wait to implement that plan until fed funds targeting was no longer effective. A contingency plan could describe, for example, what rate the FOMC would target and what tools the Desk would employ to control the new target and assess policy transmission-all elements that would also need to be developed for a proactive transition.

This section examines the benefits and costs of a proactive transition relative to a contingency plan or no action. We assess benefits and costs across four dimensions: effectiveness of policy transmission, communications, durability and transition timing. Combining these factors, our judgment is that transitioning proactively presents the best combination of benefits and costs, but making a contingency plan would also dominate taking no action.

Effectiveness of policy transmission

Changing the target rate would be costly if alternative rates provided less accurate measures of funding costs than the fed funds rate or if the FOMC's tools were less effective in controlling alternative rates. As discussed in Section 4, however, at least one repo rate (TGCR) is available that would provide a better measure of funding costs than fed funds and would be at least equally controllable.

Still, for monetary policy to transmit effectively to the broader financial system and economy, policymakers, Fed staff and market participants must have a well-developed understanding of how the operating target works, how the Fed's tools influence it, and how it relates to other interest rates and financial conditions. Even when moving to an alternative target that is closely connected to fed funds, the transition would require a learning period for both the Fed and market participants. Policy might transmit less effectively or predictably during that time. Changing targets proactively would incur this learning cost up front, while a contingency plan or taking no action would avoid incurring it until a transition was necessary.

Some private-sector activities are tied to the fed funds rate in ways that could need to change if the FOMC adopted a new target. For example, some market participants express views on near-term FOMC decisions by trading in the market for fed funds futures. The private sector could also rely on fed funds targeting in ways that are not visible to the Fed. If the private sector is unable to smoothly adjust those activities, a change in the operating target could disrupt private activity in ways that might impede policy transmission. However, because the fed funds market is fragile, these costs might arise even without a proactive change in the target. We believe these costs can best be mitigated by providing substantial advance notice of a change so the private sector can adjust. We discuss below how different strategies could affect the FOMC's ability to provide notice.

Communications

Targeting or preparing to potentially target a different rate would require the FOMC to explain how the new target related to the current one and how the transition would relate to the Committee's strategy for achieving its macroeconomic goals.

Most importantly, the FOMC would need to make clear that a change of operating target is a technical matter of policy implementation and does not represent a change in the FOMC's macroeconomic goals or its strategy for achieving them. Conveying this message would be most crucial if the FOMC made an actual change, but even the development and announcement of a contingency plan could require communications along these lines.

The reference in the FOMC's long-run strategy statement to employing the fed funds target as the primary means of adjusting the policy stance presents a difficulty in this regard. Changing the operating target would require changing the strategy statement. But we believe this communication is manageable. The strategy statement presents the fed funds target as the primary tool in order to convey that in ordinary circumstances, the FOMC does not intend to routinely employ tools other than a short-rate target, such as asset purchases. Updating that single sentence to refer to a different overnight interest rate, while leaving all other aspects of the strategy statement unchanged, would make clear the technical nature of this change.

More narrowly, it would be necessary to determine whether there would be any offset between the policy stance as expressed in the fed funds target and the equivalent in some other rate. Because money market rates are currently closely connected, no offset currently appears necessary for a repo target range relative to a fed funds target range, provided the repo target range is at least as wide as the current fed funds range. The offset could be larger, more volatile and more difficult to communicate if fed funds began to disconnect from other markets and the FOMC were forced to make a change.

Relative to a proactive change, a contingency plan would require fewer communications about the immediate implications of a different operating target but more communications about the FOMC's future strategy for changing targets. It could be challenging to pre-specify concrete criteria that would determine when or whether the operating target would change. Yet, if the FOMC did not communicate such criteria, market participants could perceive a degree of uncertainty about the FOMC's future policy implementation actions. That uncertainty would also be present if the FOMC took no action: Even without any contingency plan, market participants could recognize the fragility of the fed funds rate and the potential for scenarios to arise that would motivate the FOMC to change targets.

Durability

History shows that the U.S. money markets are dynamic and that the FOMC periodically needs to update its operating target to address changes in the markets and policy transmission. One benefit of proactively transitioning away from fed funds would be increased durability of the new target. A Treasury repo rate that is central to money markets would likely remain a viable target for longer than fed funds.

Because repo market structure is in flux amid the transition to broader central clearing, though, it is important to distinguish the durability of a Treasury repo target in general from the durability of any specific Treasury repo reference rate as the target. TGCR provides the cleanest current measure of Treasury repo conditions, but implementation of the SEC clearing mandate could change that. Developing a contingency plan but leaving it on the shelf until an immediate need arose would allow the FOMC time to further observe the evolution of repo market structure before selecting a specific Treasury repo rate as the target. Conceptually, the vulnerability of any target rate to changes in market structure could be mitigated by defining a reference rate relative to a generic underlying interest (such as "overnight repos collateralized by Treasury securities") rather than relative to a specific set of settlement platforms. However, a repo reference rate defined in that way is not currently available in the United States.

Transition timing

Communicating and adjusting to a new target rate could be more challenging for the Fed and market participants and more disruptive to monetary transmission if the transition occurred during a period of economic or financial stress. Yet it is especially important at such times for the public to understand the Fed's policy actions and for those actions to have the intended consequences. All else equal, therefore, it would be preferable to change the operating target at a time when the economy, financial system and monetary transmission are functioning smoothly.

Only a proactive change would guarantee the ability to transition during a calm period. With a contingency plan or no action, the FOMC would change operating targets when the need arose, regardless of whether the time was convenient in other respects.

Even outside of a stress period, communications and learning could be more disruptive to policy transmission if the transition occurred abruptly. By announcing a new target well in advance of implementing it, the FOMC could allow lead time for both market participants and Fed staff to make any necessary adjustments, such as developing new analytical tools or changing private-sector activities linked to the target rate. Changing targets proactively presents the best opportunity to provide a long lead time for the transition. If the FOMC waits until circumstances require a change of targets, the transition would necessarily be shorter.

Still, a contingency plan would reduce some timing costs relative to making no preparations. A contingency plan would allow the Fed to publicly outline its intentions in advance, prepare other communications and focus effort on learning about the potential new target. A contingency plan would also allow market participants to consider their readiness for a change of targets. These preparations could reduce the difficulty of implementing a new target during a stress episode.

If the FOMC waited for a breakdown in transmission between fed funds and other rates, either to make any plan or to implement a contingency plan, it might experience a period when policy transmission was undesirably impaired before it could change the target. A proactive change would avoid this risk.

Overall benefits and costs

The main benefit of taking no action is that it avoids all upfront costs, but at the expense of taking the greatest risk that transitioning to a different target rate does not proceed smoothly when it becomes necessary. That expense is potentially quite high since transmission between fed funds and other money market rates could break down during a time of economic or financial stress, when effective policy implementation is especially valuable. In our view, the upfront costs of either changing targets proactively or developing a contingency plan are small relative to the risk of having no plan.

Weighing a contingency plan against a proactive change is more complex. Most significantly, a proactive change would allow the FOMC to choose the timing of a transition but might be less durable than waiting to learn more about repo market structure before deciding which Treasury repo rate to target. In our view, however, changing operating targets during a stress episode or on short notice would be more costly than changing the target rate a second time in response to gradual evolution in repo market structure.

6. Conclusion

This essay describes the history of the FOMC's operating targets and argues that the current operating target, the fed funds rate, continues to function well but is fragile. Treasury repo reference rates, especially TGCR, would present attractive alternatives while maintaining the principle that the FOMC primarily adjusts the policy stance by adjusting the target for a short-term interest rate. The FOMC could make its operating target more robust by proactively changing to a different target rate.

Notes

1. Federal Open Market Committee, "Statement on Longer-Run Goals and Monetary Policy Strategy," Aug. 22, 2025.
2. Ann-Marie Meulendyke, U.S. Monetary Policy & Financial Markets, New York: Federal Reserve Bank of New York, 1998.
3. Robert L. Hetzel and Ralph F. Leach, "The Treasury-Fed Accord: A New Narrative Account," Federal Reserve Bank of Richmond Economic Quarterly 87(1), 2001, pp. 33-55.
4. See also Mark Carlson and David C. Wheelock, "Near-money premiums, monetary policy, and the integration of money markets: Lessons from deregulation," Journal of Financial Intermediation 33, 2018, pp. 16-32.
5. Ben S. Bernanke, "Monetary Aggregates and Monetary Policy at the Federal Reserve: A Historical Perspective," remarks at the Fourth ECB Central Banking Conference, Nov. 10, 2006.
6. Board of Governors of the Federal Reserve System, "Press Release," Feb. 4, 1994.
7. Board of Governors of the Federal Reserve System, "Press Release," July 6, 1995.
8. Board of Governors of the Federal Reserve System, "Press Release," Jan. 31, 1996.
9. See Federal Reserve Bank of New York, "Statement Regarding the Implementation of Planned Changes to the Effective Federal Funds Rate and Publication of the Overnight Bank Funding Rate," Jan. 6, 2016.
10. See Federal Reserve Bank of New York, "Statement Regarding Planned Changes to the Calculation of the Federal Funds Effective Rate and the Publication of an Overnight Bank Funding Rate," Feb. 2, 2015.
11. Specifically, the calculation of risk-weighted assets puts a higher risk weight on a bank's unsecured exposures to other depository institutions than on secured exposures.
12. See, for example, Morten Bech and Todd Keister, "Liquidity regulation and the implementation of monetary policy," Journal of Monetary Economics 92, December 2017, pp. 64-77; Kyungmin Kim, Antoine Martin and Ed Nosal, "Can the U.S. Interbank Market Be Revived?", Journal of Money, Credit and Banking 52(7), October 2020, pp. 1645-1689, and Alyssa Anderson and Manjola Tase, "LCR Premium in the Federal Funds Market," Finance and Economics Discussion Series No. 2023-071, Federal Reserve Board, Nov. 3, 2023.
13. Financial Stability Oversight Council, 2017 Annual Report, Box C.
14. See Lorie K. Logan, "Ample reserves and the Friedman rule," remarks at the European Central Bank Conference on Money Markets, Nov. 10, 2023.
15. See, for example, Sam Schulhofer-Wohl and James Clouse, "A Sequential Bargaining Model of the Fed Funds Market with Excess Reserves," Working Paper 2018-08, Federal Reserve Bank of Chicago, revised July 2018, and Gara Afonso, Gonzalo Cisternas, Brian Gowen, Jason Miu and Joshua Younger, "Who's Borrowing and Lending in the Fed Funds Market Today?", Liberty Street Economics, Oct. 10, 2023.
16. Afonso et al. (2023).
17. These estimates include only tri-party and centrally cleared repo. The Office of Financial Research began regularly collecting data on another large segment of the repo market, non-centrally-cleared bilateral repo, in late 2024.
18. Alternative Reference Rates Committee, "Interim Report and Consultation," May 2016.
19. Alternative Reference Rates Committee, "The ARRC Selects a Broad Repo Rate as its Preferred Alternative Reference Rate," June 22, 2017.
20. See James Egelhof, Ron Feldman, Jane Ihrig, Antoine Martin, Paula Tkac and Suraj Prasanna, with Troy Davig, Julie Remache and Gretchen Weinbach, "Alternative Policy Rates," memo to the Federal Open Market Committee, Oct. 7, 2016; Paula Tkac, Jane Ihrig, Kurt Lewis, Laura Lipscomb, Susan Zubradt, Patrick Dwyer, James Egelhof, Antoine Martin and Ron Feldman, "Interest Rate Targets and Operating Regimes," memo to the Federal Open Market Committee, Oct. 14, 2016; David Altig, Josh Frost, Deborah Leonard, Josh Louria and Paula Tkac, "The Federal Reserve's Target Interest Rate," memo to the Federal Open Market Committee, Oct. 19, 2018.
21. Federal Housing Finance Agency, "Unsecured Credit Limits for Federal Home Loan Banks," Federal Register 89(192), pp. 80422-80427, Oct. 3, 2024.
22. Bank of New York Mellon, "Market Structure and Growth," Jan. 23, 2025.
23. See Egelhof et al. (2016), Tkac et al. (2016), and Altig et al. (2018).
24. Bank of England, Monetary Policy Report, August 2025.
25. See Lorie K. Logan, "Opening remarks for panel titled 'Post-Pandemic Challenges for Monetary Policy Implementation," Aug. 25, 2025.
26. See Lorie K. Logan, "Opening remarks for conversation at Greater Waco Chamber," May 29, 2025.
27. For a discussion of relevant risk management steps, see Treasury Market Practices Group, "Best Practices for Treasury, Agency Debt, and Agency Mortgage-Backed Securities Markets," May 2025.
28. See, for example, Lorie K. Logan, "Financial conditions and the monetary policy outlook," remarks before the 65th National Association for Business Economics annual meeting, Oct. 9, 2023.
29. Securities and Exchange Commission, "Extension of Compliance Dates for Standards for Covered Clearing Agencies for U.S. Treasury Securities and Application of the Broker-Dealer Customer Protection Rule With Respect to U.S. Treasury Securities," Federal Register 90(41), pp. 11134-11139, March 4, 2025; Securities and Exchange Commission, "Standards for Covered Clearing Agencies for U.S. Treasury Securities and Application of the Broker-Dealer Customer Protection Rule With Respect to U.S. Treasury Securities," Federal Register 89(10), pp. 2714-2830, Jan. 16, 2024.
30. See Alternative Reference Rates Committee, "ARRC Closing Report: Final Reflections on the Transition from LIBOR," November 2023.
31. Amy Wang Huber, "Market power in wholesale funding: A structural perspective from the triparty repo market," Journal of Financial Economics149(2), August 2023, pp. 235-259.
32. See, for example, Federal Open Market Committee, "Minutes of the Federal Open Market Committee, July 29-30, 2025".
33. For a discussion of factors influencing the tradeoff between operation sizes and rate volatility in a repo targeting regime, see Jeff Huther and John McGowan, "Demand and Supply Considerations in Repo Rate Targeting Regimes," memo to the Federal Open Market Committee, Sept. 30, 2016.