Last week the Federal Reserve Bank (Fed) raised interest rates by 0.25% in its efforts to combat the high inflation that the U.S. is currently grappling with. It is predicted that the Fed will continue to raise rates until there is some indication that inflation is easing. While many people do not pay attention to this kind of news, this kind of financial activities can have a direct impact on your household finances. Let’s discuss why you should pay attention to the Federal Reserve Bank.
What Is the Federal Reserve Bank?
The Federal Reserve System is the central bank of the United States. Created in 1913, congress established 3 primary objectives for monetary policy. They are maximizing employment, stabilizing prices and moderating long-term interest rates. There are 12 regional Federal Reserve Banks scattered across the US that oversees national chartered banks within their region. There are seven presidential nominated Board of Governors who each serve 14 – year terms. The board is chaired currently by Jerome Powell [About the Federal Reserve].
Why Do We Need The Federal Reserve Bank?
There are two government bodies that control the U.S. economy. They are the government who establish fiscal policy and the Federal Reserve who establish monetary policy.
According to the Federal Reserve website, the central bank provides the nation with a safe, flexible, and stable monetary and financial system. But what does this really mean?
Well, before the federal reserve bank was established the U.S. experienced frequent financial crises. During these financial crises, citizens would lose faith in their banks and therefore withdrew their funds from them. This had a domino effect as when one bank failed, persons became anxious and pulled their funds from other banks. The 1907 financial crisis was particularly severe and threatened to break the whole banking system. This led to the 1913 Federal Reserve Act by congress that established the Federal Reserve System.
In essence having a Federal Reserve System has reduced the frequency and severity of financial crises by enacting monetary policies. This stability increases citizens’ confidence in the banking system. A system upon which capitalism heavily relies. Not only are crises less common but when they do occur, the Federal Reserve Bank is there to lessen the blow as they did in 2008. They do this by lending money to failing financial institutions so that these institutions are able to continue operations. Thus, preventing a domino effect like that experienced in the past.
Why Should You Pay Attention To The Federal Reserve?
Higher Loan Rates
While the Fed does not control mortgage rates, its decision influences mortgage rates. The Fed influences the increase/decrease of mortgage rates when it increases or decreases the Federal Funds Rate. This is the rate at which depository institutions lend to and borrow from each other. The FOMC sets this target rate. Prior to 2022, mortgage rates were at historic lows, however, that changed when the Fed started increasing the Federal Funds Rate. Now mortgage rates are climbing thus increasing the cost consumers must pay to own their homes. This is a primary reason why you should pay attention to the federal reserve.
Higher Market Volatility
The S&P500 index fell 19% in 2022. The worst performance recorded since 2008. The NASDAQ experienced an even worse performance with a loss of 33.1%. This kind of market losses have not been seen on the US market for over a decade. In fact, analysts believe the situation is so precarious that they are predicting a recession in 2023 or 2024. Investors must now be more diligent in their search for high performing stocks and expect to experience more losses for the next 12 months. The Fed decisions affect your portfolio returns, and this is why you should pay attention to the federal reserve.
Currently, the Fed’s primary focus is to lower inflation. In economics, particularly the Phillips Curve, inflation has an inverse short term relationship with unemployment. Therefore, when unemployment is high, theoretically inflation should be low. Currently unemployment is low and inflation is high. We see then that the Fed will continue to make decisions that will drive unemployment upwards in their mission to lower inflation. Unemployment can be a devastating blow to your finances. And this is why you should pay attention to the federal reserve. Learn more about inflation by reading these blogs [3 Things You Should Know About Inflation] and [Let’s Talk Inflation].