You may often hear the news that the Fed (the Federal Reserve) will reduce/raise the interest rates. However, this action will affect the appreciation and depreciation of the currency, which will also affect the entire market economy.
But do you really know enough about the Fed?
So what is the Fed? What will be the impact of the Fed raising and reducing interest rates?
Next, we will take you to understand one by one!!
What is the Federal Reserve?
Federal Reserve(Fed), is also known as the Federal Reserve System, the Federal Reserve Board, and the Federal Reserve Board of the United States. The Fed is the central banking system in the United States. The highest level of the organization is the Council, which is responsible for deciding central bank policies. It also has 12 major urban areas in the United States Federal Reserve Banks and more than 3,000 member banks of the Reserve Bank. The 12 major urban areas are including:
- New York
- St. louis
- San Francisco
The main responsibility of the Fed is to stabilize the national monetary policy, smooth financial transactions and stabilize the domestic trading market. Because the US dollar is the most important currency in the world, the appreciation and depreciation of the US dollar or the interest rate hikes and interest rate cuts will affect the global economy and the stock market.
Therefore, the Fed must maintain the stability of the US economy and avoid excessive exchange rate fluctuations.
In simple terms, the regular functions of the Federal Reserve are included:
- Promote maximum employment, stable prices and moderate long-term interest rates
- Minimize risk as much as possible to create a stable financial system
- Improve security in financial institutions
- Defend security in payment and settlement systems
- Advocating consumer protection through a supervisory stance
Who is the chairman of the Federal Reserve?
As of March 2023, the Fed chair is Jerome Powell, who took office on February 5, 2018. He is the 16th person to serve as Fed chairman. Prior to that, Powell had served on the council since May 25, 2012. He also currently serves as chairman of the FOMC’s Federal Open Market Committee, which oversees monetary policy.
The Fed’s monetary policy target rate: The Federal Funds Rate
The Federal Fund Rate of the Fed is a representative short-term interest rate in the United States, and it is also the target interest rate of monetary policy.
Why is the Federal Fund Rate the target rate for monetary policy?
To put it simply, if you have a lot of cash on hand, you usually don’t keep it with you, but you will deposit it in the bank, and private banks will also be deposited in the Federal Central Bank if they have a lot of cash on hand too. Means that, Federal funds are deposits that banks hold with the central bank.
If the interest rate of the federal funds becomes higher, in order to recover the capital, the bank will increase the interest rate on companies and the general public, making it difficult for companies and the general public to obtain loans and reducing economic growth.
If the federal funds rate decreases, banks will charge cheaper interest in order to make it easier for everyone to borrow money, which will stimulate economic growth.
Therefore, the rise and fall of the federal funds rate will affect economic development, which is also the target interest rate of monetary policy.
What is the impact of the Fed raising and reducing interest rates?
The Federal Reserve decides the US monetary policy and adjusts interest rates through the Federal Open Market Committee (FOMC) according to economic needs.
If the FOMC believes that the economy is growing too fast, while the inflation and prices are likely to rise, and it will raise the federal funds rate;
If the FOMC thinks the economy is struggling and may be in a recession, it will reduce the federal funds rate.
Raising interest rates = Making loan interest rates higher, slowing down economic development;
Reducing interest rate = Economy faces recession, stimulus money coming in, revitalizing the market.
1. The prosperity and slump of economic
Raising interest rates = higher interest rates = lower consumption, reduce investment, cool down the stock market
Mainly to suppress excessive inflation caused by overheated economic activities, the purpose is to suppress the prosperity and stabilize the currency
Reducing interest rates = lower interest rates = stimulate consumption, increase investment, heat up the stock market, which can boost the economy and revitalize the market.
2. The appreciation and depreciation of currency
The Fed’s monetary policy has attracted worldwide attention. If the Fed raises interest rates, then the global capital will flow to the US dollar, while the US dollar will strengthen, and other non-US currencies will be relatively weak.
It should be noted that the central bank of each country can affect the appreciation and depreciation of its own currency to a certain extent, so that the real effect of currency appreciation and depreciation depends on the response of other currencies.
If the dollar depreciates and other central banks also devalue their currencies, no one is really relatively weak, and the flow of funds is difficult to predict.
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Disclaimer: Information above can only be use for references and doesn’t represent our platform’s opinions.