What is the “Fed,” and What Does a Rate Increase Mean for Me? What is savings fitness?
The Federal Reserve System—more commonly known as the "Fed"—is the central banking system of the United States and is the part of the federal government that regulates the country’s financial institutions. Its board of governors oversees its 12 Federal Reserve Banks, as well as a number of branches. The Fed not only serves as the country’s central bank, but it also studies economic trends and makes policy decisions with the intention of creating a healthy economy. What is savings fitness?
Although the Fed is part of the federal government, it is an independent agency, meaning it can make decisions on its own without approval from any other government branch. However, the Federal Reserve chairman regularly testifies to the House of Representatives and the Senate, since the Fed is subject to questions from Congress over its actions. Janet Yellen is the current Fed chairperson, appointed on Feb. 3, 2014, for a four-year term ending Feb. 3, 2018.
Why was the Fed created? And when?
A series of U.S. bank collapses around the turn of the 20th century pushed many in Congress to call for a centralized banking system (after two failed attempts to do the same thing during the 1800's). On Dec. 23, 1913, President Woodrow Wilson signed the Federal Reserve Act, and the Federal Reserve System was born.
What does the Fed do?
The Fed has three main goals:
- Achieve maximum employment levels
- Stabilize prices
- Moderate long-term interest rates
In other words, it is the job of the Fed to make sure that the country’s banking system is solid and that the economy is healthy. The Fed achieves this by doing the following:
- Making decisions about monetary policy in order to reduce unemployment
- Keeping prices stable
- Keeping interest rates at the right level
- Supervising and regulating banks for security and consumer confidence
- Protecting consumers’ credit rights
- Monetary Policy
A key task of the Fed is to make decisions over monetary policy. This involves regulating interest rates and regulating the availability of money. If the economy needs to grow faster and more jobs need to be created, the Fed can supply more credit to banks for lending purposes. It can also lower the interest rates that banks use to borrow money from the Fed, making it cheaper for banks to lend. This is referred to as the
discount rate—the interest rate that an eligible bank is charged if it borrows short-term funds directly from a Federal Reserve Bank.
How does the Fed affect U.S. citizens?
The Fed has a major impact on the daily lives of nearly every American. For example, buying a home or a car can be more expensive if you have to pay more interest on a loan. An even greater impact could be an increase in unemployment as businesses struggle with the increased cost of borrowing money due to the higher interest rates, and, firms may want to lay off people instead of hiring them.
Also, if the Fed cuts back on buying securities, it is lowering the amount of money circulating in the economy—thus, creating less consumer spending. Of course, the opposite is true as well. The Fed can encourage consumer spending by lowering interest rates and borrowing costs—making a home or car purchase cheaper. And, that could also mean that businesses could borrow money at a lower rate and may then think more about hiring if the economy picks up steam and consumers are spending more.
The Fed in the Future
Since 2006, the federal funds rate has been set at a range of 0 percent to 0.25 percent. On Dec. 16, 2015, the Fed announced a widely anticipated increase to the target federal funds rate by .25 percentage points. The new range is 0.25 percent to 0.50 percent. Even though it is a small amount, it could affect your bank account, 401(k), adjustable-rate mortgage loan (ARM) and even your credit card.
Experts say that this first rate hike in nearly a decade might not have much of an impact overall. However, this is only the first of a series of gradual rate increases that are expected to occur throughout 2016. The Fed will be monitoring inflation and employment levels, which are sure to influence those decisions. Here is a breakdown of what you may expect in regards to your own finances.
The Fed has little influence over long-term, fixed-mortgage rates, which are pegged to yields on U.S. Treasury notes, so don't expect higher mortgage rates to affect your ability to buy a home or to refinance in the near future. However, with interest rates rising, ARMs could increase. If you have an ARM, don't be surprised to see some payment increases in the future.
Keeping cash in a savings account has yielded close to nothing for years, aside from peace of mind. That isn’t likely to change much any time soon. The average interest rate on a savings account is 0.08 percent, according to Bankrate.com—less than the rate of inflation. Even with a Fed rate hike, banks may not pass any of that increase on to their customers for a while.
Federal student loans with a fixed interest rate won't be impacted by a rate hike. But if you have a private loan with a variable rate, that rate is likely to rise, meaning the interest you pay on the principal of the loan will rise as well. Any increases are expected to be small, however, and shouldn’t be too noticeable.
401(k) investors who look at the long-term effect of the rate increase should be optimistic, since a rising interest rate is a sign of a healthy economy. If you own a 401(k), be prepared for a little bit of short-term volatility, since bond prices fall when rates rise, and bond funds are a big part of many 401(k) plans. Investors who hold on for the long-term ride should see higher returns from those higher coupon bonds.