If you’ve ever flicked over to a financial news channel, you’ve probably heard the term “the Fed.” But who, or what, exactly is the Fed? And why does it matter to you?
Here, we explain the Federal Reserve System, or the Fed, and explore how its decisions can affect your everyday life.
What is the Fed?
“The Fed” stands for the Federal Reserve System, the USA’s central banking system. It was established by Congress in 1913 and is an independent entity that was designed to bring stability and integrity to the country’s monetary and financial system.1
The Fed has five general functions, including:
- Conducts the nation’s monetary policy
- Promotes the stability of the financial system
- Promotes the safety and soundness of individual financial institutions
- Fosters a safe and efficient payment and settlement system
- Promotes consumer protection and community development
The Fed also has dual objectives, which are often referred to as the dual mandate.2 The first objective is to promote maximum sustainable employment, which translates to as many Americans having jobs as possible while keeping inflation steady. The second objective is to maintain stable prices for the goods and services we purchase. In doing so, the Fed aims to foster a healthy economic environment in which businesses can grow and people can build wealth.
How Often Does the Fed Meet?
The Federal Open Market Committee (FOMC) is the branch of the Fed that is responsible for making decisions about the money supply and interest rates and meets regularly to evaluate the economic conditions and adjust its policies accordingly.3 The FOMC meets eight times a year, or about every six weeks. It consists of twelve members: seven members of the Board of Governors, the president of the Federal Reserve Bank of New York, and four rotating Reserve Bank presidents.
The FOMC’s discussions and decisions significantly impact the nation’s economy. In the FOMC meetings, the Fed makes crucial decisions about monetary policy, especially around the federal funds rate, which is the interest rate at which banks lend to each other. This rate indirectly affects other interest rates, such as those for mortgages, car loans, and credit cards, as well as the rates paid on savings accounts and money market funds.
The Fed also makes decisions about quantitative easing measures, which involve the Fed buying government securities or other securities from the market to lower interest rates and increase the money supply, encouraging lending and investment.4
How the Fed Impacts You
Decisions made by the Fed have a direct impact on the average investor. When the Fed raises or lowers interest rates, the cost of borrowing and the return on savings and investments are impacted.
When the Fed lowers interest rates, borrowing becomes cheaper, which can lead to increased spending by consumers and businesses. This surge in demand can boost the economy and potentially lead to higher stock prices. However, lower interest rates mean savers and investors earn less on their money, which can push them to look for higher returns for their investments.
Conversely, when the Fed raises interest rates, borrowing becomes more expensive, which can slow economic activity. This can lead to lower stock prices, as businesses might see their revenue decrease, and consumers may cut back on spending. However, savers and bond investors can benefit from higher interest rates as they earn more on their investments.
The Fed plays an instrumental role in steering the economic course of the nation. Its decisions affect not only big businesses and banks but also the average American and their financial future. By understanding the workings of the Fed and its influence on the economy, individual investors can make more informed decisions about their investments.