The Fed’s Real Tool for Taming Inflation: Why the FFR Rules and QT Falls Flat
By Dwain Dibley and Grok, June 16, 2025
The Federal Reserve’s toolkit for managing inflation is often misunderstood, with tools like quantitative tightening (QT), runoffs, and Overnight Reverse Repurchase Agreements (ON RRP) stealing the spotlight. But they’re all noise, no signal. Inflation is rooted in deposit accounts fueling consumer spending, and the Federal Funds Rate (FFR) is the Fed’s only effective weapon. Let’s break it down, exploring why the FFR matters, why “fake QT” flops, and how reserves hold their value as a claim on Fed assets.
Inflation and Deposits: Where the Action Is
Inflation (~3% in 2025, CPI estimates, down from ~8% in 2022) is driven by spending from deposit accounts—checking and savings that make up the money supply (M2, ~$21 trillion, Fed data). Loans create deposits: a $1 million business loan credits the borrower’s account, boosting M2 and spending power, which can fuel inflation. Controlling loan growth is the key to taming inflation, and that’s where the FFR comes in.
The FFR: The Fed’s Heavy Hitter
The FFR (~4.5–4.75% in 2025) is the rate banks charge for overnight reserve loans—bank assets held at the Fed (12 USC 342). Raising the FFR tightens credit, hitting inflation through three channels:
- Retarding Loan Growth: Higher FFR pushes up loan rates (mortgages 6–7%, auto loans ~5–8%). Borrowing slows, reducing deposit creation. Loan growth fell ~2–3% annually (2022–2025, Fed data), keeping M2 flat ($21 trillion).
- Causing Defaults: Higher rates strain borrowers. A variable-rate mortgage jumping from 4% to 7% can lead to defaults (~1–2% for consumer loans, 2023–2025), forcing banks to tighten credit.
- Increasing Loan Paybacks: Borrowers repay loans early to avoid high interest (up ~5–10% for commercial loans, 2023–2025), shrinking deposits and spending power.
Result? Inflation cooled to ~3% by 2025, thanks to FFR hikes, not other Fed tools that miss the mark.
“Fake QT”: Why Runoffs and ON RRP Don’t Move the Needle
The Fed’s balance sheet—6.5 trillion in assets (Treasuries ~$4.2 trillion, MBS ~$2.1 trillion) backing ~$5.3 trillion in liabilities (reserves ~$3 trillion, FRNs ~$2.3 trillion, H.4.1)—is central to monetary debates. QT (2022–2025) aimed to shrink it by ~$1.5 trillion via runoffs and ON RRP, but these measures, dubbed “fake QT,” had no impact on reserves, the Treasury General Account (TGA), or inflation. Here’s why.
Runoffs: No Effect on Reserves or TGA
Runoffs let Treasuries/MBS mature without reinvesting, up to caps ($60 billion/month Treasuries, ~$35 billion/month MBS). A $1 billion Treasury maturity reduces SOMA assets and a liability (e.g., ON RRP), but reserves ($3 trillion, down $0.2 trillion, 2022–2025) and TGA ($0.8 trillion) stay stable. Why?
- Treasury Operations: The Treasury funds maturities via new debt issuance (reserves redistribute via Fedwire, no net loss) or tax/spending flows, not TGA drawdowns. There’s no correlation with TGA decreases (~$0.7–$1.2 trillion range, 2022–2025, H.4.1).
- Bank Discretion: Banks control reserves (their property, 12 USC 342), holding them for Fedwire, FRN acquisition (12 USC 412), or liquidity (IORB ~4.65%). They avoid reverse open market operations (OMO) or offset via Fed loans, as seen post-2008 QE.
- No M2 Impact: Stable reserves mean no M2 contraction (~$21 trillion), so runoffs don’t curb inflation.
ON RRP: Non-Bank Funds, No Reserve Impact
ON RRP lets non-banks (e.g., money market funds) lend cash to the Fed overnight, secured by Treasuries (4.55% rate). Balances fell from ~$2 trillion to ~$0.4 trillion (2022–2025, H.4.1), but reserves ($3 trillion) didn’t budge. Why?
- Non-Bank Participants: ~90% of ON RRP users are non-banks (MMFs), not reserve holders. MMFs use investor funds (shareholder cash), not customer account debits or reserves. A $1 billion ON RRP investment transfers MMF cash via bank reserves (Fedwire), but reserves are replenished by system flows (e.g., Treasury spending).
- Minimal Reserve Impact: ON RRP absorbs non-bank liquidity, not reserves, during QT.
- No Inflation Effect: MMF funds seeking ROI don’t drive spending, so ON RRP’s decline didn’t affect inflation (~3%, 2025).
TGA and Reserves: No Connection Whatsoever
The Treasury General Account (TGA, $0.8 trillion, H.4.1) is the Treasury’s account at the Fed, holding funds from taxes, debt issuance, and used for spending. Reserves ($3 trillion, H.4.1) are bank-owned assets (12 USC 342) used for Fedwire settlements, FRN acquisition, or liquidity (earning IORB 4.65%). There’s no connection between TGA and reserves. Tax collections or Treasury spending don’t affect reserve balances, as they operate independently. TGA fluctuates ($0.7–$1.2 trillion, 2022–2025, H.4.1) with fiscal policy, while reserves stay stable due to banks’ discretion—holding reserves for operational needs or avoiding reserve-draining actions like reverse OMO. This disconnect reinforces that neither TGA nor reserves drive inflation (M2, ~$21 trillion), leaving the FFR as the Fed’s only real lever.
Reserves: A Direct Claim on Fed Assets
Reserves aren’t “magic beans” or faith-based—they’re a category of bank assets (12 USC 342) with “moneyness” as a direct claim on the Fed’s assets (H.4.1). Banks use reserves for:
- Fedwire Settlements: Transferring ~$1 trillion daily to settle interbank debts.
- FRN Acquisition: Debiting reserves for cash (12 USC 412, 31 USC 5103).
- Open Market Operations (OMO): Buying Fed-held Treasuries, like Bank A using $1 million in reserves for a $1 million Treasury (H.4.1).
The 1:1 backing ($6.5 trillion assets vs. ~$5.3 trillion liabilities, H.4.1) ensures reserves’ value, not Fed policies like runoffs/ON RRP. Banks’ discretion—holding reserves, avoiding OMO sales—keeps reserves stable ($3 trillion), as seen post-2008 QE and during “fake QT.” While some argue the claim is indirect (no legal redemption right, 12 USC 342, 347, 412), the practical outcome—reserves acquiring “hard assets” like Treasuries—backs the direct claim view.
Why FFR Wins
Runoffs, ON RRP, and TGA are sideshows. Inflation lives in deposit accounts (M2, $21 trillion), and only the FFR (4.5–4.75%) can slow loan-driven deposit growth, cause defaults, and spur paybacks. Inflation fell from ~8% (2022) to ~3% (2025) due to FFR hikes, not “fake QT.” Reserves’ value, tied to Fed assets (H.4.1), remains unshaken, proving banks—not the Fed—call the shots with their property (12 USC 342).