FRB Interest Rates: Why do They Matter?
Updated: Jun 3, 2023
*Not financial advice - your money, your choice*
Jerome Powell Picture from Tenor
The Federal Reserve (the “Fed”), is the central bank of the United States. Think of the Fed as the boss of all the other banks. Like any boss, it has a lot of responsibilities one of which is to set the federal funds rate. Basically, it's like the price tag on money that banks use to lend to each other overnight.
The federal funds rate has a significant impact on the economy as it affects the cost of borrowing for both you and the business you work for as well as the businesses you shop at. When the federal funds rate goes up, it gets more expensive for you to borrow money for large purchases like homes, cars, or that unicorn you’ve been dreaming about.
An increase in interest rates can also cause the value of the dollar to increase which may make everything feel cheap when you travel abroad but this can also make it more difficult for U.S. businesses to compete with foreign businesses. It's like when your friend gets a really cool new toy and suddenly all the other kids want one too. If the value of the dollar increases, foreign businesses' products and services become cheaper, which is not good for American businesses.
When American businesses start cutting costs, it can lead to a decrease in investment spending which can have a negative impact on economic growth, widening the trade deficit, and job creation. And no one wants to lose their job, right?
It also gets much more difficult to pay off debt which can lead to defaults and bankruptcy. As an example, if you carry debt on your credit card, the interest rate will likely increase making it harder and harder to pay off.
But, it’s not all bad news. Federal Reserve rate hikes can have some positive effects on the economy too! They can prove to be useful for controlling inflation and promoting long-term stability. So, it’s a bit of a balancing act. Policymakers must carefully weigh the risks and benefits to make sure they’re taking steps to minimize the chance of recession and high unemployment.
In short, what may seem like a boring topic, can have a huge impact on your daily life so keep an eye on those interest rates!
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