The Fed

I have recently been reading Alan Greenspan’s book The Age of Turbulence and I am pretty fascinated with the way the Fed works as a result (that and I am an econ major, hence me reading the book to begin with). With that in mind I have set out to better understand what it is the Fed does and how it does it.

The Fed is the central bank for the United States and is in charge of monetary policy with the main goal of controlling inflation. With that in mind they have used varying methods to try to stabilize the economy over the years. The most effective way of keeping inflation in check has been to control interests rates, since a lower interest rate means more spending and a higher one means less spending. More spending drives prices up and causes inflation to ensue.

The most important interest rate is the federal funds rate which is the rate that banks loan money to each other. The Fed sets a target federal funds rate and then tries to keep it there by performing what are called open market operations. These are when the Fed buys US Treasuries in order to alter the amount of money in the economy. When there is more money in the economy it is easier to access, which results in lower interest rates. When there is less money in the economy it is harder to get and this causes banks to raise their interest rates.

Knowing the federal funds rate is important to know for a number of reasons. First, it is an economic indicator and once you get the feel for it you can tell what the Fed believes the economy is doing. All businesses pay close attention to the Fed meetings to see if they will raise or lower the funds rate as an indicator of whether the economy is going into a recession or boom. Also, it is used as the base for many other important interest rates including the prime rate, which is the standard rate used by banks to make many loans and often the underlying rate used in variable rate credit cards.