March 14, 2024
Could the Fed funds rate impact your wallet?
Rate changes can trigger a chain of events.
You’ve probably heard of the Federal Reserve, also called the Fed, but do you know how the Federal Reserve may impact your finances?
It’s important to understand what the Federal Reserve is because its actions can affect interest rates. It can also be helpful to know how federal funds rate fluctuations could impact you financially.
What is the Federal Reserve?
The Federal Reserve was created in 1913 by the Federal Reserve Act to serve as the nation’s central bank. It also sets monetary policy in the U.S. with its decisions having a direct impact on the country’s economy and your personal finances. According to the Federal Reserve website, there are three key features of the U.S. banking system:
- A central governing board
- 12 Federal Reserve Banks
- A blend of public and private characteristics
The governing board of the banking system is called the Federal Reserve Board of Governors. It reports to Congress as a federal agency in Washington, D.C. The board members provide general guidance for the Federal Reserve System and oversee the 12 Reserve Banks. The Board also submits a Monetary Policy Report twice a year covering economic developments and plans for monetary policy.
The 12 Banks were established throughout the county to ensure that policy decisions represent all regions. The U.S. Government Accountability office explains that Federal Reserve policies should work to promote “maximum employment, stable prices, and moderate long-term interest rates.”
What is the federal funds rate?
The Fed funds rate is the interest rate U.S. depository institutions, such as banks, will pay each other when loaning or borrowing money overnight. When the rate falls, certain types of consumer loans can become less expensive to service and vice versa.
Changes in the rate trigger a chain of events affecting:
- Short- and long-term interest rates
- Foreign exchange rates
- The amount of credit available
If you learn that the Federal Reserve has increased or decreased interest rates, then you’ll know the Fed has voted to adjust the Fed funds rate. This can affect the interest rate on credit cards and loans. A rate change can eventually impact a range of economic variables, including employment and the prices of goods and services.
How does the Federal Reserve evaluate inflation?
According to the Federal Reserve, inflation is the increase in the prices of goods and services over time in the U.S. economy. The Federal Reserve monitors inflation to ensure that costs don’t climb too quickly.
The Federal Reserve also tracks various price indexes for signs of inflation. A price index measures changes in the price of a group of goods and services. To better manage debt and savings when prices are rising, you may want to check out our article on understanding inflation and its effects on the economy.
Why do interest rates matter?
Interest rates matter because they influence the borrowing costs and spending decisions of households and businesses. Lower interest rates encourage more consumers and businesses to borrow money. For example, you may choose to buy a new car when interest rates are low so you can pay less total interest over the life of the loan.
Higher interest rates often restrain borrowing but can be a benefit to consumers who want to save. When interest rates go up, banks typically raise the rates on interest-earning accounts, such as high-yield savings accounts and certificates of deposit.
When the economy is struggling, the Fed lowers rates to encourage borrowing and spending. If it’s doing well, the Fed may raise rates to prevent the economy from overheating. The more informed you are about the direction of rates, the better you can budget and plan for the future.
