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I have always seen( since 1990s) that the Fed changes( cut/increase) interest rates in quarter point increment /decrements in USA that affect the world bond, stock market and borrowing rates, while I see world news where the ECB cuts by 10 points and India by unconventional 35 basis points and again.

So what economics data is used by the Fed, and what mathematical operation ( Monte Carlo ?) is done on the data, to arrive at quarter points result?.

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    tradition is not an answer. question is good. If market becomes volatile with 25 points, it could be less with a 20 points or 30 points, so decimal is better.
    – riya
    Aug 1, 2019 at 16:20
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    skeptics.stackexchange.com/questions/44590
    – riya
    Aug 1, 2019 at 16:28
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    changing interest rate is like seekingalpha.com/article/2376585-the-fed-is-changing-gear ,so having more gear is better quora.com/…
    – riya
    Aug 1, 2019 at 16:33
  • @d-stanley thanks for trying to answer, but simplicity/Tradition can not solve the trillion dollars
    – Raj
    Aug 4, 2019 at 17:34
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    The link you provide does not show that the Reserve Bank of India cut rates by 35 basis points, but rather that a single contrarian economist said he believed they would. Two days after that article, the RBI did indeed lower rates... by 25 basis points, similar to all their recent rate changes. RBI appears to use 25 basis points as the basic increment/decrement, just as the US Federal Reserve.
    – user4556274
    Aug 4, 2019 at 20:38

3 Answers 3

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According to A Model for the Federal Funds Rate Target at page 13

changes as small as 6.25 basis points were sometimes observed prior to 1990

Similarly, according to The Relationship Between the Federal Funds Rate and the Fed's Federal Funds Rate Target: Is It Open Market or Open Mouth Operations? at page 4:

In late 1989 the Fed began the practice of adjusting its funds rate target only in multiples of 25 basis points. Prior to that target changes were made in various amounts, with changes as small as 6.25 basis points.

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    That's a quarter of a quarter point.
    – RonJohn
    Aug 1, 2019 at 14:32
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    @davephd thanks, what reason the fed has given to stop using a 6.25
    – riya
    Aug 2, 2019 at 13:57
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    @riya I'm not aware of them giving any reason, but this article seems to have some additional information. pdfs.semanticscholar.org/baa5/… It seems to me that going from 1/16 to 1/4 point increments coincided with the committee being more public about what the target was, but I could be wrong.
    – DavePhD
    Aug 2, 2019 at 14:43
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    @davephd for the link, I will read it some point. And recognizing the issue a bit
    – riya
    Aug 2, 2019 at 16:12
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I'm pretty sure it's just a policy that the Fed seems to follow. I know of no mechanical reason why they couldn't use more precise increments, but possibly for simplicity (or tradition) they choose to use more granular rates than other countries seem to.

Keep in mind that influencing interest rates is an inexact science. The Fed will set rates at a certain value with the goal to increase (or decrease) spending and borrowing in order to influence inflation and other key economic measures. So there's really not much benefit gained by issuing bonds at more fine-grained rates since the market can dictate an effective interest rate via the price that they decide to pay for the new bonds.

It's like having a volume knob on your stereo with 100 notches instead of 10 11. Having extra precision doesn't really buy you that much, and just makes it harder to decide what volume you want (you can more easily choose if 5 or 6 is better then you can 53 or 54).

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    Additionally to @D Stanley's remarks I guess one could take behaving according to local traditions and historical factors into account. In the US a quarter is a common unit - e.g. quarter dollar coins and rooted in people's speech - e.g. quarter pounder. In the EU (non UK) quarters aren't very common in connection with money (at least I don't know any EU country's (former) currency, which (had) has quarters). So I guess it is a bit like the question "Why don't Americans use metric system?" - with the difference, that using quarters isn't a very big disadvantage unlike non-metric units ;-)
    – pcalc
    Jul 31, 2019 at 6:34
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    Huh? The Fed doesn't issue any bonds. Your description of the market fine-tuning a fixed coupon matches instead Treasury auctions and markets (other than bills). The FOMC 'policy rate' officially applies primarily to the interbank overnight repo market, and apparently in practice also to the discount window. The former being an open market affected by other participants is why the policy rate is stated as a range (as of today's meeting 2.00-2.25) not a point.
    – dave_thompson_085
    Aug 1, 2019 at 0:10
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    @d-stanley simplicity so guidance can be 25 basis points v/s 22 or 32 points, calculate the cost of the simplicity on Trillions of $ from either perspective( borrower/lender)
    – riya
    Aug 2, 2019 at 14:02
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    @riya OK so how do you calculate those "costs"? What difference does it make if the target is 2.25 versus 2.1738? Based on your comments and answer I think you're looking for justification of a view that "the fed is evil/corrupt/stupid" (which may be true) but it's not helpful in my opinion.
    – D Stanley
    Aug 2, 2019 at 14:18
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    @d-stanley , I am not implying what you said, I am just looking for the "secret sauce" that Fed use, ( if they use), else it seems arbitrary.
    – riya
    Aug 2, 2019 at 16:11
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+50

If Fed is really using statistical techniques, then it is impossible to come at an answer in multiple of 25 points unless they are targeting an objective, else they are using guess work and using tradition as the excuse. OLD quarter point system, could benefit the ultra rich, they should use the decimal points increase similar to stock market.

Doctors prescribe antibiotics or other medicine by weight very precisely in developed countries like USA, but in developing countries a child is given half of the antibiotics( where the child may be even 1/5 th weight of adult dose or 3/4th. So in Medical science we progressed, but not in banking.

With that said, there is no real reason for this kind of policy/tradition or simplicity.

Interest rate has a ripple effect across the entire U.S. economy and economist use gear analogy ( also ) then in cars more transmission are better, same is true with interest rates.

Ask big corporation how even a single point change affect: $9 trillion corporate debt

Or ask a student how does a single point affect , students collectively has 1.5 Trillion in debt.

Or ask a saver/retiree, who is not getting a fair safe return. Balance is key and it comes with precision. more granular interest rate change can generate efficiency.

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    Some counterpoints: 1) Medicine is dosed is broad increments (ever try to buy 132 mg tablets of aspirin?) 2) the effect of setting interest rates is not precise since it depends on irrational human behavior in markets. So there's no scientific evidence whether the rate should be 2.25% or 2.1738%.
    – D Stanley
    Jul 31, 2019 at 13:49
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    quora.com/Why-do-some-people-think-that-the-Earth-is-flat It is 21st Century, if there is an increase or decrease in any number there has to be science behind it.
    – riya
    Jul 31, 2019 at 14:03
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    @riya "It is 21st Century, if there is an increase or decrease in any number there has to be science behind it." Didn't you know that economics is the Dismal Science?
    – RonJohn
    Jul 31, 2019 at 14:10
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    @riya my point it that is is not "guess work", but that the effect is imprecise (the rate incentivizes people to borrow more or less money, which affects how much they spend, which affects inflation) so there's no point in arguing over whether the rate should be 2.25% or 2.1738%. Other countries choose more precise increments, which is fine, but there's not a mathematical problem that quarter-point increments causes.
    – D Stanley
    Jul 31, 2019 at 14:11
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    @d-stanley thanks for comment , the question may be opinionated. But why not FED takes then passive approach, if it does not know how much exact % point change is needed. if an increase of 15 points was necessary, and FED increase by Quarter point, after 3/6 months later they will come back and decrease by quarter points so, it looks as if FED is busy and doing something.
    – riya
    Jul 31, 2019 at 19:24

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