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Inflation

The Fed Speaks—Should You Listen?

The Federal Reserve's monetary policies can have a dramatic impact on the economy, directly affecting inflation and unemployment.

04/24/2023
Speaking platform in government office.

Key Takeaways

The Federal Reserve (Fed) is the central bank of the United States and has the power to influence lending activity and financial markets in the U.S.

The Fed's dual mandate is to maximize employment and maintain stable prices through monetary policy and by controlling the money supply.

The Federal Open Market Committee (FOMC) determines whether to raise or lower the federal funds target rate.

Get our take on the latest Fed meeting.

The U.S. Federal Reserve’s (the Fed’s) monetary policy has far-reaching effects. With its role in setting short-term U.S. interest rates, the Fed has the power to affect lending activity and financial markets in the U.S.

But it also may directly impact your daily life. Via its federal funds rate, the Fed affects interest rates on savings accounts, mortgages, car loans, credit cards, investments and more. Fed policy also influences U.S. economic and market conditions.

In recent years, the Fed’s influence has only become more apparent. In particular, policymakers responded to the COVID-19 pandemic and the wildly shifting economy with rate cuts and massive financial support.

Fed Structure and Dual Mandate

The Fed is the central bank of the U.S. Established in 1913 under President Woodrow Wilson, the Fed is comprised of three parts.

  • The Board of Governors provides general guidance and oversees the branches.

  • The Federal Reserve Banks comprise the operating arm of the Fed. There are 12 regional Federal Reserve Banks across the country.

  • The Federal Open Market Committee (FOMC) examines the economic and financial environments and sets interest rate policy.

The sitting U.S. president nominates the Fed’s seven-member board of governors, and the Senate confirms the nominees. The president also appoints the Fed chair and vice chair from the sitting board of governors. However, the Fed theoretically operates independent of the federal government.

The Fed has a dual mandate: to maximize employment and to maintain stable prices (i.e., promote an average annual inflation rate of 2%). It seeks to achieve this mandate through its monetary policy and by controlling the nation’s money supply.

This monetary policy process becomes most visible through the actions of the FOMC. Members typically meet eight times a year to examine and discuss the economic and financial environment.

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FOMC Sets Rate Policy

The FOMC determines whether changes to the Fed’s monetary policy, including hiking or cutting the federal funds target rate, are warranted. The target rate is the interest rate banks charge each other for overnight loans. It’s an important benchmark for short-term interest rates.

Financial markets around the globe closely monitor FOMC meetings and the resulting policy statements. Even the anticipation of policy changes might affect economic conditions and market performance.

The FOMC adjusts monetary policy by:

  • Purchasing or selling Treasuries and other government bonds—known as quantitative easing and quantitative tightening, respectively.

  • Lowering interest rates to encourage borrowing and spending, which fuels economic growth.

  • Increasing interest rates to raise borrowing costs, curtail spending and temper an overly hot economy and high inflation.

Potential Effects of FOMC Policies

Impact on Lending and Savings Rates

The federal funds rate target influences other interest rates, including consumer lending rates and interest paid on savings and money market accounts.

Lowering the federal funds rate makes it cheaper for banks to borrow cash. Banks can pass down those lower rates to consumers, who subsequently enjoy lower credit card interest rates and lower mortgage rates.

While lower interest rates can spark consumer spending, they also may make saving money less desirable. Fed rate cuts also result in lower interest rates on savings accounts, certificates of deposit (CDs) and money market funds.

On the flip side, when the Fed raises the federal funds rate to tame inflation, consumer lending rates also rise—and savings rates rise, too.

Rate Changes and Employment

The Fed also relies on the federal funds rate target to promote maximum employment. For example, when the unemployment rate is high, cutting the target rate may spark economic growth. A boost in economic activity ultimately should promote hiring.

On the other hand, rising wages and robust employment typically contribute to higher inflation rates. The Fed may raise the federal funds rate target to get these economic measures back in balance.

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Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.

This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.