BUDGETINGLIFESTYLE & TRAVEL

The Federal Reserve and What it Means for You

Inflation has been a big topic of conversation lately. You’ve probably noticed the prices of goods you buy every week have gone up considerably in the past year or two. Among other things, this is a residual effect of policy established by the Federal Reserve, also known as the Fed, to get the country through difficult economic circumstances caused by the coronavirus pandemic. The Federal Reserve is the central bank of the United States that aims to provide a strong, stable U.S. dollar. But how does the Fed affect your everyday money habits?

How does it affect financial institutions?

The Federal Reserve acts as a lender for financial institutions like banks and credit unions. These institutions can borrow money from the Fed, and similar to how you pay interest on a loan, there is an interest rate referred to as the Federal Funds Rate. When you hear that the Fed is raising or lowering rates, this is the rate that is being referred to.

Financial institutions consistency evaluate their rates for products such as mortgages, auto loans, and certificates. When the Fed lowers rates, financial institutions typically lower their rates as well. During the coronavirus pandemic, the Federal Funds Rate was lowered to help encourage spending to keep more people working while many businesses closed. Lately, we’ve seen rates rising. The Fed is attempting to lower inflation by limiting the spending of Americans. The idea being that if demand is reduced, prices will fall to meet demand, thus lowering inflation. It can take a while for the effects of these rate hikes to be felt, but eventually the market catches up.

How does it affect borrowers and savers?

For a person borrowing, interest rates are critical. A few percentage points in interest can mean a big difference in the total payment toward a loan. So, as a consumer, rising Federal interest rates might mean the monthly payment for the car you wanted to buy is going to be higher. This might mean that you pick a less expensive car or stick with your current vehicle a while longer. This is an example of the Federal Reserve reducing spending in the economy.

On the other hand, financial institutions can offer better rates on savings accounts and certificates. This means a person who puts money into their savings account will earn more on their money in returns or dividends. This money not being spent means the economy doesn’t benefit from those dollars being in circulation. This is another example of the Fed reducing spending.

The ultimate goal is to maintain a moderate level of inflation, but realistically, inflation cycles between periods of being higher and lower, so gradual rate hikes and reductions are to be expected. Knowing which way rates are trending can inform your spending and saving decisions!

Sources:

https://www.forbes.com/advisor/investing/fed-raises-interest-rates/

https://www.federalreserve.gov/faqs.htm