Fed Rates and Inflation
So what exactly does the federal reserve do? People are always talking about how they’re the bank for banks but what does that even mean? What is their official job and how do they help to fight against things like inflation?
‘Basically the federal reserve or Fed fights against things like inflation in two ways. First by setting the level of interest rates banks borrow their money. In addition they also set the capital requirement banks must hold in reserve when leading the money out. Why does this matter because the interest rate they set greatly affects the interest rate terms retail banks give out on loans to the customer.
When the federal reserve makes rate cuts what they mean is that they’re lowering the borrowing rates for banks that borrow money from the federal reserve. The hope is that cheaper rates for the banks translates to lower rates for real people for stuff like car and home mortgages or business loans. The reason they do this to stimulate the economy. The idea is that if you give ppl money at a lower rate they’ll be more inclined to spend it which in turn…
The opposite happens when the Fed decides they want to raise rates. Think about supply and demand. If the people who are selling know the people buying have money to spare (increased supply) they will increase the prices of their good and services to take advantage of the new demand. Thats why college has become so expensive over the past 50 years. The Government is the Buyer so the seller (the schools) increased their cost in order to bring new services like sports and arts programs to the school.
Fed cuts are good for the economy when they happen because cheap money = more production but it can also signal that the economy is weak and in need of stimulus. On the opposite If they believe the money supply has gotten out of hand they will raise rates to curb inflation. Why is inflation bad well in addition to just a overall higher cost of living for the same necessities A seemingly small inflation rate of 3% will erode the value of your savings by 50% over approximately 24 years. The whole job of the Fed is to keep the balance between being productive and avoiding inflation.