While you’ve probably heard about Federal Reserve interest rates, do you picture a giant question mark when this topic comes up? Spoiler alert: federal interest rates are a big deal and impact your daily life more you might think.
So, what is the Federal Reserve?
First things first—what exactly is the Federal Reserve (aka the Fed)? Basically, the Federal Reserve System is the United States’ central bank. Its goal is to “promote the effective operation of the U.S. economy and, more generally, the public interest.”
They run monetary policy that aims to maximize employment and stabilize prices. (Yep, they’re the ones who control inflation). The Reserve also supports individual financial institutions and monitors how they impact the financial system as a whole.
The Fed’s services help with transactions and their research analyzes consumer issues and trends. They even delve into community economic development activities and administer consumer laws and regulations.
Then what is a Federal Reserve interest rate?
The Federal Reserve operates based on the monetary policy, actions. These actions are “to achieve three goals specified by Congress: maximum employment, stable prices, and moderate long-term interest rates in the United States.”
This means they can tweak how much credit is available in the economy and how much credit costs you.
Banks are most directly affected by the Fed interest rate. This is the rate which banks and other institutions that hold money use to lend money to each other. Banks legally have to keep a minimum portion of their customers’ money on reserve. Since they’re not allowed to earn interest on that amount, they lend it back and forth to other institutions to stay as close to that limit as possible. Learn more about how banks work.
Why do interest rates change?
The Fed’s goal is to keep the federal funds rate at or near a target set by the Federal Open Market Committee (FOMC). When the target changes—or is projected to change—interest rates paid by borrowers and earned by savers go up or down accordingly.
For example, with the onset of a recession, the FOMC lowered its target for the federal funds rate close to zero at the end of 2008. This was done in hopes of bolstering the economy, making it easier for people to borrow and spend. Interest rates went up again once the nation stabilized. Recently, there was a Fed rate cut down to near zero in anticipation of the financial crisis due to the COVID-19 pandemic.
Interest rates change with the state of the country. The more stable the job market and the economy, the higher the Fed raises interest rates. This is because the system—and Americans—can support it. And vice versa.
*For all you history buffs, check out this timeline.
What do interest rate changes mean to you?
Something as large-scale as the central bank of America may seem too lofty to comprehend, but their decisions can have a concrete impact on your life.
Interest-bearing savings accounts may earn less when Fed interest rates are low. On the flip side, when national interest rates are high, your credit card and loans (such as home, auto, and business), will likely go up as well.
If you have enough wiggle room in your budget and financial goals, consider borrowing according to the economic landscape. For example, if you’re buying a home when interest rates are low, focus on locking into a fixed-rate mortgage. If you borrowed interest rates were high, consider refinancing when rates are lower if the costs work out in your favor.
While the Federal interest rate is not the be-all-end-all of your financial well-being, it can have an effect on large and small aspects of your personal wealth. Stay up to date on changes to the Federal Reserve interest rates here.