The Fed and Interest Rates
November 6th, 2008 | by admin |
The Fed, or the Federal Reserve Bank, is the government’s bank. It is also considered the banks bank and is important to the balance of our economy. It handles all of the United States government’s money and banking transactions. The Fed also governs a number of banks, setting limits on the charges that they can charge their patrons. The Fed controls these banks charges for services, overdraft fees, loan interest rates, and also insures your money held in an account at one of these banks.
One of the main jobs of the Fed is maintaining a harmony in the economy. It does this by maintaining full employment. This means keeping unemployment at a minimum (around 4 or 5 percent), while keeping inflation low. This is a fragile balance that the Federal Reserve Bank must maintain for economic function. One of the ways the Fed balances these factors is by it’s ability to influence interest rates.
The economy constantly fluctuates, even during periods of economic stability and economic depression. When bank interest rates are lowered, the economy booms. This is because more and more people are able to invest more money at a lower rate of pay back. This is economic stability. Even though the economy seems to be flourishing, low interest rates can have a drawback. When interest rates are low and pay back rates are low, there is more money available to be spent on other goods and services. This in turn causes merchants to raise their prices, because they figure that if everyone has extra money to spend, they should see higher profits. This is called inflation.
Economic depression occurs when interest rates are high. This is because the purchaser is required to pay more to payoff loan balances. High interest rates also cause longer periods of time to pay back, hence keeping your money tied up. Because of this, people don’t have extra money to spend causing an economical recession or in worst cases, deflation.
The Fed controls these situations in one of two ways, raising or lowering the discount rate or indirectly influencing the Federal funds rate. Interest rates charged to banks borrowing from the Federal Reserve Bank is referred to as the discount rate. When these rates are low, the bank charges you, the consumer, lower fees for services. This is because capital is less expensive. When interest rates on money borrowed from the Federal Reserve Bank are high, the cost naturally is passed on to you. This is in the form of more costly services and loan interest rates.
The Federal funds rate is the interest that banks charge each other for loans. The Fed can require banks to have a certain amount of cash on hand or a percentage deposited into a Federal Reserve Bank. The Fed also governs how much of these funds must be vaulted. When money is vaulted, it means that the money is basically in storage and makes it harder and more expensive to use. However, when the Fed releases this hold, more money is available, making it easier and less expensive to acquire capital.
The cost of the Federal fund rate charged to banks is also passed onto you, the consumer. This is in the form of the banks prime lending rate. The prime lending rate is the interest rate the bank charges it’s best customers. The prime lending rate varies from bank to bank, depending on the banks costs.
The delicate balance between the Fed and the economy is constantly changing. This is why we have periods of economical strength and weakness. The Federal Reserve Bank is responsible for keeping this balance in check. The Fed consistently keeps tabs on who is spending what and where and adjusts rates accordingly. Because of these measures, the balance is maintained and the economy can thrive. When this balance is upset in any fashion, our economy suffers. This, in turn, makes the Fed’s job all the more important.