21 Oct

Interest Rates and the Federal Reserve

The collapse of the world financial markets during late 2008 and into 2009 led many Americans to question the role, and ability, of the Federal Reserve to manage the monetary policy of our country. While the experts debated whether the Federal Reserve went too far or not far enough, the rest of us were asking more basic questions such as, “What does the Federal Reserve really do?”

The Federal Reserve: Then and Now

To truly understand the Federal Reserve’s role in our national economy today, it helps to look at how and when the Federal Reserve was created. During the Bank Panic of 1907, Wall Street turned to fellow banker and investor J.P. Morgan to steer the country through the crisis that threatened to push America into a depression. Morgan was able to convene a select group of principal financial players at his New York mansion and command that their individual and business capital flood the system and, therefore, float the banks. As a result, the banks then had the funds to support struggling businesses, providing them with enough capital to carry them through until the panic passed. These actions by Morgan saved the economy and forced the U.S. government into acting on its on-again, off-again plans to create a Central Bank. It was this near-miss that lead to the passing of the Federal Reserve Act in 1913.

The Role of the Federal Reserve

The Federal Reserve, commonly referred to as The Fed, doesn’t actually “set” the interest rates that prevail in the U.S. or world financial systems. Rather, the Fed’s mandate is “to promote sustainable growth, high levels of employment, stability of prices to help preserve the purchasing power of the dollar and moderate long-term interest rates.” In other words, the Fed’s job is to foster a sound banking system and a healthy economy by serving as the bankers’ bank, the government’s bank, the nation’s money manager and the regulator of financial institutions.

How the Federal Reserve’s Actions Can Influence Interest Rates:

Open-Market Operations

The Fed constantly buys and sells U.S. government securities in the financial markets, which in turn influences the level of interest rates in the banking system. This buying and selling also affects the volume and the price of credit. This is the most powerful tool at the Fed’s disposal.

Discount Rate

This is the interest rate that banks pay on short-term loans from the Federal Reserve. This can affect how much banks charge people that borrow money from the bank.

Reserve Requirements

This is the amount of physical funds a financial institution is required to hold in reserve against deposits in customer accounts. It determines how much money a bank can loan to its customers. For example, the more reserves the Fed requires, the less the bank can loan.

Influence, Not Control

It’s important to remember that the Fed does not dictate market interest rates. It merely tries to influence them. That said, the Fed’s actions can have a direct effect on the amount and cost of credit in the economy. This in turn can affect everything from interest rates on your mortgage or the return on certificates of
deposit to the level of growth in the U.S. economy.

Stay True to Your Goals and Your Plan

Regardless of the direction taken by the Fed, or resulting fluctuations in the market, the key for investors is to stay focused on the long term. Discuss your questions or concerns with an experienced financial advisor. Together you can map a strategy to reach your financial goals and not only understand, but weather,
various economic conditions.

Jeffrey C. Hamm is a Financial Advisor with Navigator Financial Planning Services located at Navigator Credit Union. If you have any questions, or would like to provide feedback regarding the information presented in this article, you may contact Jeff at 228-474-3427.

Representative is not a tax advisor or legal expert. For information regarding specific tax situations, please contact a tax professional. For legal advice, consult an attorney.
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