Posts Tagged ‘Federal Reserve’

Why and how do interest rates increase and decrease?

Thursday, November 5th, 2009

Interest rates reflect the price of borrowing money. The Federal Funds Rate, the interest rate for banks borrowing money from one another, is determined by the Federal Reserve. The Fed meets eight times a year to determine if they should change the interest rate, though they can meet more frequently if there’s a crisis (such as the economic meltdown in late 2008).

The most important factor in determining the interest rate is supply and demand. If many people are buying houses and cars, the demand for funds will be high because people want to borrow money to spend, and banks want to profit from that demand. So during an economic boom, interest rates tend to be high. In an economic downturn, interest rates are very low to encourage borrowing and stimulate the economy.

The Fed’s monetary policy dictates their decision on whether to “loosen” or “tighten” the money supply. The Fed has the power to inject money into the economy – essentially printing cash, which lowers the interest rate as there is now more money available to borrow. On the other hand, the Fed can also “tighten” the money supply, by buying bonds and essentially withdrawing money from the economy, decreasing the money supply and increasing the interest rate.

Another important factor in interest rate fluctuation is whether we are in an inflationary period. If the economy is threatened by high inflation, the Fed will increase the interest rate to discourage borrowing.

The interest rate should be important to a consumer who wants to borrow money and is also a key factor in understanding how our economy functions.

Who is “the Fed?”

Monday, November 2nd, 2009

The “Fed” is the Federal Reserve, otherwise known as our national banking system. There are 12 Federal Reserve banks scattered across the country; their job is to loan money to local banks, who then loan it to the people. The Fed is controlled by the Federal Reserve Board, which consists of seven governors chosen by the President and approved by the Senate. The Board’s responsibilities include determining monetary policy, making reports to Congress, overseeing national banks, consumer protection, and discount rates, and setting standard requirements for other banks or institutions that store money.

The most important thing the Board does is head up the Federal Open Market Committee (FOMC), which meets eight times a year to discuss monetary policy. The FOMC consists of the seven members of the Federal Reserve Board, the President of the Federal Reserve Bank of New York, and four of the other eleven Federal Reserve Bank Presidents, who take turns serving on the Committee. The FOMC votes to determine the discount rate (the interest rate at which the Federal Reserve lends to other banks), how much capital banks will be required to have on hand for financial security, and open market securities (how and with which companies the Federal Reserve will trade).

The Recession Is Probably Over, But It’s Still No Party

Thursday, September 24th, 2009

Just because a recession is ending doesn’t mean huge growth right away. It’s interesting to see what the future may hold after such a terrible economic spell.

  • On Tuesday, Ben Bernanke – the Federal Reserve chairman – said that it was “very likely” that the recession has already ended, though the problems it caused will still linger for a while.
  • Forecasters predict that we will only experience moderate growth for the rest of 2009 through 2010 – the problems affecting credit markets, consumer confidence, and the housing crisis still need time to be fully solved.
  • One of the most important problems that needs to be addressed is how the government is going to carefully dismantle the spending, lending, and guarantee programs it put in place to stabilize the economy – too quickly and we could be back to more problems, but too slowly and significant inflation could set in.

Facts & Figures

  • Retail sales in August surged by 2.7% in July – the largest increase since January of 2006.
  • Growth in 2010 is predicted to be moderate, not much faster than the basic growth rate of the economy.

Best Quote

“Without these speedy and forceful actions, last October’s panic would likely have continued to intensify, more major financial firms would have failed, and the entire global financial system would have been at serious risk.” – Ben S. Bernanke, Chairman of the Federal Reserve

What does it mean to say “the Fed is raising the interest rate?”

Wednesday, September 23rd, 2009

At any given time, there are countless different interest rates for countless different transactions at countless different institutions. The government doesn’t control all of them – how could it? But then how can you say the Fed has raised or lowered interest rates?

The Fed, or the Federal Reserve, is the whole country’s bank. It operates out of 12 different locations and it lands money to commercial banks, which in turn land money to us. The Federal Reserve Board is the agency that controls this bank and its job is to maintain a secure financial system throughout the country. The Fed’s primary concern is to regulate our economy’s rate of growth – if the economy grows too quickly, we get swamped by inflation, and if it grows too slowly, we could enter a recession.

Because the Fed lands money to all other banks, its interest rate affects all other interest rates, which adjust to accommodate the Fed’s behavior. So when the Fed decides the economy is growing too fast, it raises its own interest rate – raising all other interest rates in a kind of domino effect – and slows down spending that way. If the Fed wants to try to increase economic growth, it lowers its interest rate, which usually increases spending. While interest rates can vary from institution to institution, they’re all proportional to the country’s most important interest rate: the Federal Reserve’s.

How Much Power Should We Give The Fed?

Tuesday, August 18th, 2009

How big should government be? Below, the Fed chairman’s arguments for why, when it comes to consumer protection, bigger is better.

  • Federal Reserve chairman Ben S. Bernanke has been spurring debate about the Fed’s proper role, arguing that it is necessary to give the government more authority.
  • Bernanke wants the Fed to maintain control over consumer lending, an opinion which differs from the policies of the Obama administration.
  • Many officials are skeptical of this plan, arguing that the government is already spread too thin, and that it cannot possibly become a successful systemic risk regulator.

Facts & Figures

  • Bernanke’s plan requires the government to examine the possible dangers posed not just by companies themselves, but by their connections to other corporations.
  • The Fed would also require big corporations to keep debt low or capital high, restricting them to a manageable size and increasing competition.
  • The government would be granted the authority to seize any institution it deemed too great a danger to the financial system.

Best Quote

“…[T]here’s got to be somebody who is responsible not just for monitoring the health of individual institutions, but somebody who’s monitoring the systemic risks of the system as a whole. And we believe the Fed has the most technical expertise and the best track record in terms of doing that.” – Barack Obama

The Federal Reserve is…

Wednesday, August 5th, 2009

The Federal Reserve (or “the Fed”) is the government agency that sets monetary policy, which means they try to control inflation and affect people’s spending habits by changing interest rates. The Fed also controls the discount rate, which is an interest rate that makes it cheaper or more expensive for banks to borrow and lend money.