In the video below, I explain how “the Fed” works in just three minutes.
Following the Fed is not a great spectator sport like watching the NBA Finals or seeing motorcycles jump off ramps.
But their decisions affect your interest rate – which is your cost of money.
The Federal Open Market Committee has 12 members and they manage the U.S. money supply. They want economic growth and stable prices.
Now why would the Fed raise interest rates on you? To cool an overheating economy, which helps slow inflation.
Just think about it.
If interest rates were high, like 15%, how motivated would you be to borrow to launch or expand your business, or borrow to buy an income property?
Not so likely; that’s a high interest rate.
You’ll hear the term rate “hike” a lot. It means a rate raise. I wish they’d just say “raise”.
Why exactly does the Fed raise rates to combat high inflation, anyway?
High inflation makes consumers lose faith in currency. High inflation also means variable inflation, and that makes it difficult for people to plan.
Now oppositely, why would the Fed lower interest rates? To stimulate a sluggish economy.
See. If rates are low, like 3%, now you have INCENTIVE to open a business or buy property. You will stimulate economic activity.
You’ll see the media use the terms “hawk” and “dove” to describe the Fed’s temperament.
A hawkish stance means the Fed is guarding against high inflation. Therefore, a hawkish Fed would quickly raise rates to put the brakes on inflation.
A dovish stance means the opposite. They DON’T take aggressive action. When they signal that they’re not going to change rates, that’s a dovish tone.
The Fed has eight regularly scheduled meetings each year. This is where they announce if there’s an interest rate change, usually a quarter-percent at a time.
Financial markets watch these meetings closely.
The President nominates the Fed Chairperson for a four-year term. Then the Prez and the Fed Chair are supposed to be independent from each other.
This means that sitting Presidents shouldn’t make any suggestions about the Fed’s direction.
But some have. Donald Trump has made remarks to current Fed Chair Jerome Powell to chill with the rate raises.
You see, Presidents don’t want to see the economy be slowed during their term. They want lower rates so that economic activity is stimulated under their watch.
There’s way more to The Fed. This is just a keep-it-simple overview.
Though the play-by-play is about as interesting as watching your neighbor whack weeds, know that the Fed affects your cost of money.
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