(emphasis mine) [my comment]

Federal funds rate
From Wikipedia, the free encyclopedia

In the United States, the Fed Funds Rate is the interest rate at which private depository institutions (mostly banks) lend balances (federal funds) at the Federal Reserve to other depository institutions, usually overnight. It is the interest rate banks charge each other for loans. Changing the target rate is one way the Chairman of the Federal Reserve can influence the supply of money in the U.S. economy. The Federal funds target rate is determined by a meeting of the members of the Federal Open Market Committee which occurs every two months.

Mechanism

U.S. banks and thrift institutions are obligated by law to maintain certain levels of reserves, either as reserves with the Fed or as vault cash. The level of these reserves is determined by the outstanding assets and liabilities of each depository institution, as well as by the Fed itself, but is typically 10% of the total value of the bank's demand accounts (depending on bank size).

For example, assume a particular U.S. depository institution, in the normal course of business, issues a loan. This dispenses money and decreases the ratio of bank reserves to money loaned. If its reserve ratio drops below the legally required minimum, it must add to its reserves to remain compliant with Federal Reserve regulations. The bank can borrow the requisite funds from another bank that has a surplus in its account with the Fed. The interest rate that the borrowing bank pays to the lending bank to borrow the funds is negotiated between the two banks, and the weighted average of this rate across all such transactions is the federal funds effective rate.

The nominal rate is a target set by the governors of the Federal Reserve, which they enforce primarily by open market operations. That nominal rate is almost always meant by the media referring to the Federal Reserve "changing interest rates". The actual Fed funds rate generally lies within a range of that target rate, as the Federal Reserve cannot set an exact value through open market operations [KEY POINT: the fed does not have absolute control over interest rates. In fact, when faced with abnormally strong fears over deflation or inflation, the fed loses any control over interest rates. See chart below].

Below is a federal funds chart from the New York Fed. Notice how, when deflation fears shook Wall Street in September, the fed lost all control over the federal funds rate. The fed's target rate was 1.5% while the real interest rate was close to zero.

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My reaction: I felt it was important to point out that the fed can only control short term interest rates during normal times.

1) There are two federal funds rates:

A) The federal funds nominal rate = target interest rate set by Federal Reserve
B) The federal funds effective rate = real interest rate

2) The interest rate which is always being reported by the media is the nominal rate (ie: not the real interest rate).

3) The fed lost control of interest rates last September.

Conclusion: Although it was severe deflation fears which caused the fed to lose control of interest rates last September, inflation fears can also (and will) cause the fed to lose control of interest rates in the other directions.