The Fed is about to raise interest rates again — here’s how it happens and why it matters

Jerome Powell rate hike

The Federal Reserve on Wednesday is set to raise its benchmark interest rate for the seventh time since late-2015.
The US central bank adjusts the interest rates that banks charge to borrow from one another, which is eventually passed on to consumers.
Economists expect that this time, the Fed will make a slight tweak to how it usually raises rates.

Banks give out money all the time — for a fee.

When we borrow and then pay back with interest, it’s how banks make money.

The cost of borrowing, known as the interest rate, can make a big difference in which credit card you choose or whether you get one at all.

But if your bank wants to make it more expensive to borrow, it’s not as simple as just slapping on a new rate, as a grocer would with milk prices. It’s something controlled higher up by the Federal Reserve, America’s central bank.

Why does the Fed care about interest rates?

In 1977, Congress gave the Fed two main tasks: keep the prices of things Americans buy stable, and create labor-market conditions that provide jobs for all the people who want them.

The Fed has developed a toolkit to achieve these dual goals of inflation and maximum employment. But interest-rate changes make the most headlines, perhaps because they have a swift effect on how much we pay for credit cards and other loans.

From Washington, the Fed adjusts interest rates with the hope of spurring all sorts of other changes in the economy. If it wants to encourage consumers to borrow so spending can increase, which should boost economic growth, it cuts rates and makes borrowing cheap. After the Great Recession, it kept rates near zero to achieve just that.

To accomplish the opposite and cool the economy, it raises rates so an extra credit card seems less and less desirable.

The Fed often adjusts rates in response to inflation — the increase in prices that happens when people have more to spend than what’s available to buy.

For most of this economic recovery, inflation hasn’t really picked up, although it’s now well within the Fed’s target. But that’s expected to change, since the federal government has provided a jolt in the form of tax cuts and the unemployment rate is at the lowest level since 2000.

For now, the Fed is not exactly raising rates to fight inflation, though it expects prices to rise. That’s why the most closely watched issues on Wednesday include the Fed’s forecasts for economic growth and future rate hikes.

So how do rates go up or down?

Banks don’t lend only to consumers; they lend to one another as well.

That’s because at the end of every day they need to have a certain amount of capital in their reserves. As we spend money, that balance fluctuates, so a bank may need to borrow overnight to meet the minimum capital requirement.

And just as they charge you for a loan, they charge one another.

The Fed tries to influence that charge — called the federal funds …read more

Source:: Business Insider


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