Trying to understand how the economy, the Federal Reserve, and even gas prices affect the credit card in your wallet can be difficult. However, along with other factors, they are all closely related.
Most financial transactions involving banks revolve around the Federal Reserve and the interest rates they set. The Federal Reserve sets the Federal Funds Rate, which is basically the rate of interest that banks and thrift institutions are expected to charge when borrowing money from one another. Each financial institution is required to keep a certain amount of money in their reserves (usually about 10% of the money they have on hand). If the amount of money they are lending to consumers takes them under this limit, they have to borrow it from another institution to keep their levels up. This keeps everything in a nice balance.
Your credit card interest rates are based upon the Prime Rate, which is, at the moment, 3% higher than the Federal Funds Rate. So, if the Federal Funds Rate goes up, then the Prime Rate goes up as well (and vice verse). Your actual credit card interest rate is applied one of two ways; you will have a fixed rate, meaning it does not move up or down with Prime, or you will have a variable rate. The variable rate will be set at Prime plus a certain amount. All of this information will be in your original credit card agreement papers.
The Federal Reserve is an important player in the current economic downturn. When the economy needs a boost, the Fed can lower interest rates to stimulate business. The less interest consumers have to pay, the more likely they will borrow. However, this also means financial institutions are making less money on each loan they issue, which can lead to bankruptcy.
Another big issue in finance today is the amount of Subprime loans that were issued in the last 15 years. Subprime loans are mortgages for people who have less than perfect credit. They are considered alternative loans, meaning they are based less on credit scores and more on income and current payment histories. These loans have helped many people buy houses that would not have been able to otherwise. The problem banks are facing now is that many of these mortgage holders are now foreclosing on their houses. High unemployment rates and even gas prices are making it nearly impossible for many homeowners to keep up on their payments. This is creating huge losses for the banks issuing loans. When a house is given back to the bank there isn't a whole lot they can do with it other than try to sell it to someone else, but once again, with unemployment and high gas prices, there aren't a lot of buyers out there right now.
When this happens, the Federal Reserve steps in and lowers interest rates once again. It does give consumers a break, but hurts the bank at the same time. The Fed's job is to try to keep how much it helps consumers and how much it hurts the banks in balance.
Of course there are many more factors that determine your personal finances, but these are some of the basics to help you better understand how the national economy effects your own.
