How the Fed Money Policy Affects Your Life

The Federal Reserve System influences more of your life than you might think. Prices, interest rates, investments, and savings–major determiners of your quality of life–are largely controlled by the Federal Reserve Board Chairperson and her board of governors. And, they’re meeting next week to make a big decision about your future.

Janet Yellen is Chairperson of the Fed (for short). This is one of the most powerful positions in America. She, along with her seven Board of Governors in Washington, D.C., plus 12 Federal Reserve District Banks in major cities across the country and over 2900 member banks make up the central banking system of America.

Technically not a government agency and supposedly non-partisan, the Fed does four things that affect you every day:

1. Conduct monetary policy to influence the level of money and credit conditions

2. Regulate banks to protect consumers

3. Maintain stability of the financial system and markets

4. Provide financial service to include the nation’s payments system

The Fed function that affects you and me most is number 1. When America is in an economic recession, much of the remedy is to get more money flowing in the economy, so more consumers can buy more things, which increases production, which increases employment. Conversely, when inflation sets in, the Fed takes money out of the flow, so consumers will slow down their buying causing prices to go down. These actions are accomplished in a number of ways. The Fed, as the central bank, loans money to member banks for loaning out to businesses and consumers. All banks have to maintain certain reserves or percentage of deposits that can’t be loaned out. The Fed sets these reserve rates to either increase or decrease money available to loan. The Fed also buys and sells government securities (treasury notes and bonds) based on the need to heat up or cool down the economy. They buy securities from citizens at a premium to infuse money into the economy, and they sell securities to citizens at a discount to extract money from the economy. Finally, and this impacts most of us individually and directly, the Fed sets the discount rate, or interest rate, that they charge banks for reserve money. This ultimately determines what interest you pay on everything from credit cards to car loans to mortgages.

This rate has been as high as 20% in 1980 when inflation was rampant to .25% in 2008 when recession took over. It has been between .25% and .50% since 2008 going years without an increase. Last December the Fed raised the interest rate by 25 basis points, or .25%, placing it at .50% for the first time since 2006. Ms. Yellen is hinting now that the economy may be progressing enough to warrant another increase. On September 21, her Board meets to make that decision. There is political pressure during an election year to raise the rate, since that signifies a less recessionary economy.

Whatever happens next Wednesday, I think it’s very probable that the interest rate is going to start going up at regular intervals. And, it should, since it has been artificially low for years as the Fed has manipulated it to keep us from deeper recession. It’s been nice to have low rates on cars, houses, etc., but it is not letting the economy work naturally. The up side of higher rates is that our investments–stocks, IRA’s, 401K’s–will be more fun to watch. It all influences your quality of life, so watch it with interest. You will see plenty of news reports over the next few days speculating on whether the rate will move. I’m wanting to see a series of small, incremental increases over the next year. What do you think?

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