You may have heard of the Federal Reserve or “The Fed”—but what is it and how does it affect you? The Federal Reserve is the central bank of the United States and even though it acts as an independent agency, it’s still part of the federal government. Some people call it the bank for banks.
Their goal is to encourage high employment and economic growth while also keeping inflation under control.
To accomplish this outcome, the Fed has a number of tools it can use, but one key tool is its control over interest rates—which is the cost of borrowing money.
The same way people borrow money from banks, banks need to borrow money from somewhere as well. That’s where the Fed comes in. And when banks borrow money from The Fed – The Fed gets to decide what interest rate banks will pay on their loans.
When The Fed raises or lowers interest rates for banks – the rate that banks charge consumers for everything, including credit cards, auto-loans and home mortgages are effected.
But how does this impact the economy?
If the economy is not doing well, The Fed will likely lower interest rates to encourage business expansion and increase consumer spending, which can help kick-start a sluggish economy. And if an economy is growing too fast—and inflation goes up—the Fed can increase rates so growth can be slowed and stabilized.
These decisions, along with other policy choices, are made by twelve leaders within The Fed called the Federal Open Market Committee.
The Federal Open Market Committee is made up of The Fed Chairman who is appointed by the President, the Fed Board of Governors, and a rotating group of regional Federal Reserve Bank Presidents.
The decisions made at The Fed are largely isolated from political pressure because, one, members of the Board of Governors serve fixed terms, two, The Fed is not held hostage by congressional funding and, three, the authority given to the President of the United States to remove a member from office for “just cause” has rarely been used.
The Federal Reserve plays a major role in the U.S. and understanding how it operates can be beneficial when trying to understand broader economic policy.
To learn more about the Federal Reserve and how it influences the economy, visit InformationStation.org.