The Federal Reserve is the central bank of the United States. It changes its target interest rates to keep the economy at a healthy rate of growth. As Kavan Choksi / カヴァン・ チョクシ says, the Fed tends to raise when the economy is too hot, and is experiencing the risk of high inflation. On the other hand, it may lower its rates when the economy is sluggish to boost activity to a healthy level. The Fed basically manipulates overall interest rates by lowering or raising the federal fund rate. This essentially is the rate at which banks borrow and lend funds to one another short term to maintain a reasonable balance of cash in their vaults.
Kavan Choksi / カヴァン・ チョクシ briefly discusses how the Fed influences the purchasing power of the consumers
The credit system exists so that people can immediately spend money and buy the things they want or need, rather than waiting to save enough money to make a purchase. The lower the interest rates, the more people would be willing to borrow money to make big purchases like cars and property. Basically, when consumers pay less in interest, they tend to be more willing to spend more. This invariably creates a ripple effect of increased spending throughout the economy.
The Fed’s interest rate decisions are bigger than just influencing the price you pay to borrow money and the amount you’re paid to save. All of those factors have a prevalent influence on your purchasing power as a consumer. Lower interest rates typically stimulate the economy and help juice up the job market can help fuel demand so much the supply is unable to keep up. This is what essentially happened in the aftermath of the Covid-19 pandemic.
Higher Fed interest rates are an important tool to weigh on price increases. However, consumers do not feel its impact immediately. The Fed is unable to drill for oil or produce more food. All they can do is weigh on demand to an extent that it balances back out with supply, thereby leading to a lower pace of price increases. It may take an entire year, if not more, for a rate hike to make its way through the entire economy.
Inflation has improved to a significant level since surging to a 40-year high of 9.1 per cent in June 2022. However, it is still above the 2% goalpost of the Fed. The Fed look at the personal consumption expenditures, or PCE, index from the Department of Commerce in order to gauge the inflation rates.
The spending of businesses is also impacted by the changes in the interest rates made by the Fed. As Kavan Choksi / カヴァン・ チョクシ mentions, businesses and farmers do benefit from lower interest rates., and it encourages them to make large equipment purchases or even expand into new areas due to the low cost of borrowing. This essentially helps in creating a cycle in which economic output and productivity increase. Higher interest rates tend to consumers to cut back on spending. Banks toughen their standards as well, making fewer loans.
