The Federal Reserve and Interest Rates «

The Federal Reserve and Interest Rates


March 11, 2009
The Federal Reserve serves as the Central Bank of the United States. It serves a variety of purposes to help direct the economy. These purposes are:

•maximum employment
•stable prices
•reasonable interest rates
•stable, sustainable economic growth
Interest Rates
Interest rates are often the focus when we hear about the Federal Reserve (Fed). The level of interest rates is used by the Fed to control the amount of money circulating in the economy. The interest rate that the Fed most often uses is the federal funds rate. The federal funds rate is the interest rate that banks charge when they make overnight loans to each other. The use of interest rates to control the economy is one tool of Federal Reserve monetary policy.

If the Fed thinks that there is too much money circulating in the economy, they will raise the federal funds rate in order to curb borrowing and lending. This action will make credit less available in the economy.

On the other side of the coin, if the Fed thinks that there is too little money circulating in the economy, they will lower the federal funds rate in order to curb borrowing and lending. This will make credit more available in the economy. When interest rates are lower, the economy is stimulated. Consumers can more easily buy services and products.

The Credit Crisis
During late 2007, the federal funds rate went up as banks became fearful of loaning to each other. The Fed eventually had to lower the federal funds rate in order to calm fears and restore confidence in the financial markets. In September of 2007, the Fed cut the federal funds rate ½ point to 4.75%. By January 2008, that rate had to be cut to 3%.

It didn’t seem, by 2008, that lowering interest rates was working to restore confidence in the financial markets and restore credit flow. Lehman Brothers failed, Bear Stearns and AIG were bailed out, and the TARP program was passed in order to provide funds to big financial institutions that were in danger of failing.

By October of 2008, the federal funds rate was 1% and now, in March 2009, it is between 0% and .25%.

 

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