The Federal Open Market Committee ended its two day meeting today and has decided to increase the Federal Funds Rate to 0.75% form 0.50%. A relatively small change but still on track for what the Federal Reserve wants for their long term goal. Janet Yellen, Chair of the Federal Reserve, also mentioned three more possible rate increases for this year. What do these rate hikes mean for the people of the United States? Lets break down the reasons why the Fed lowers and raises rates and how this impacts us. Mind you, these rates also affect investors from around the world, but we will focus only on the United States to simply the matter.
The rate has increased a quarter of a percent. Many might ask, what’s the big deal? Well it is a big deal if you want to buy a house, get a loan, open a credit card or buy a card. That’s right. These rates are all affected by the Federal Reserve’s monetary policy of raising or lowering their Federal Funds Rate. The Federal Funds Rate is the rate banks charge one another when giving an overnight loan to meet a bank’s(borrower) excess reserves percentile. These excess reserves are in place to limit the possibility of bank failure if too many of their customers suddenly want to withdraw their money. Now, since this specific rate affects banks when they loan money to each other over night, they have to then pass the higher rates to us to cover the cost. Thus, we are charged with higher loan rates and mortgage rates.
Generally, this is how we are affected by higher rates. Remember, the Fed does not control any other rate other than the Federal Funds Rate. Their rate only influences other rates in the market.
Sine the Fed only controls one rate, why lower/raise it? To control inflation. Simple as that. Let me break it down to the smalls form.
The Fed lowers the Federal Funds Rate. This influences banks to lower their rates. People are motivated to acquire loans since rates are so low. More money is then pumped into the economy with all these loans being created. Loans make construction projects possible, new homes are built, businesses buy more inventory which increases sales and thus employment, new businesses are created and inflation increases if it is too low. Lastly, consumer confidence increases over time and hopefully, the economy has a robust growth.
If the economy is going way to fast or coming out of a recession, like present day, then the Fed increases rates decrease inflation. This limits the amount of money pumped into the economy and lets the economy run without too much involvement from the Fed.
We can go into detail how this affects government bonds and securities but we will leave it another time where I will take us back to the year of 2008, the beginning of The Great Recession.
Janet Yellen was asked today about how fiscal policy, Congress and President spending and budget, will affect their role in increasing rates but she said there was “great uncertainty” about possible future policies.
How the amount of uncertainty grows.