Personal Finance

You don’t have to be an economist to understand the Federal Reserve

By August 6, 2019 No Comments

When the Fed talks, people listen.


Because the Fed’s main job is to help keep the U.S. economy humming along. You don’t have to be an economist to understand why that’s a good thing.

Broadly, the Federal Reserve, aka the Central Bank — created by the Congress under President Woodrow Wilson in the wake of some bank crashes — gives the country a safe, stable monetary and financial system.

The Fed has several goals that help to shore up the economy: keep employment high and keep inflation in check, among other things.

One of the main duties of the Federal Reserve is to determine interest rates. Every six weeks or so, they have a meeting to talk about the economy, employment rates and assorted other financial things. The media is always all over this meeting. Are they going to cut rates? Raise them? Leave them alone?

Former Deputy Treasury Secretary Sarah Bloom Raskin

Tom Williams | Getty Images

Last week, the Fed cut the federal funds rate, which in turn affects the interest rates set by banks, credit card companies and so on.

What does that mean? And more important, what does it mean for you?

“First, we have to look at how bad policy affects households and small businesses,” said Sarah Bloom Raskin, a Duke University professor and former deputy Treasury secretary and Federal Reserve governor. “It’s a critical function and a critical insight.

“We want people to understand that Fed policy does affect their economic well-being.”

Despite her substantial background, Raskin keeps it real.

To the surprise of her Fed colleagues, she visited a job fair in her neighborhood in 2012 to get a closeup look at the labor market. It’s crucial to get more data and more experiences, she says. “The employment rate is not a sole indicator of economic well-being,” Raskin said.

Following is an edited transcript of Raskin’s remarks about the Fed’s activities and tasks.

Q: What does the Federal Reserve do?

Among other things, the Fed determines interest rates, how costly it is to borrow money. People borrow money for all sorts of things — to buy houses, cars, for education.

The Fed does not directly change any mortgage rates or car loan rates. It doesn’t have that level of direct engagement with every lender. Instead, it controls something called the federal funds rate. That’s the rate that banks charge each other when they borrow from each other.

That rate — the federal funds rate — has the effect of trickling through into other borrowing rates. If the federal funds rate is higher, it means banks have to pay more for funds that they are borrowing. And that will, of course, make them charge more when they are lending.

Q: Anything else?

The Fed also determines whether banks are engaging in safe and sound lending.

That means, are they [the banks] doing lending in a safe and sound way to borrowers? The Fed does examinations of banks, and if they’re not operating in a safe and sound way, the Fed will take enforcement action against a bank.

The Fed also looks very carefully at the payments system to make sure that it is working.

When people buy and sell goods and services, money is passed back and forth. And money has to be drawn from one person’s account and put into another person’s account.

Q: Why should I care if interest rates go up or down?

Whether you’re a borrower or a saver — and, of course, some people are both—the levels of interest rates matter. Low interest rates might mean you’re not going to get such a nice return on your savings.

Then, if you’re a borrower, you can refinance your mortgage and actually pocket a little bit more on a monthly basis.

Q: How do interest rates impact employment?

If interest rates are too high, then firms and businesses don’t want to make investments. Actually, their costs may be so high they have to lay off workers. When they lay off workers — who are also consumers — then these workers cannot consume. So that is the circle.

When interest rates are lower, it’s a virtuous circle.

If the economy is expanding at the right pace, because interest rates have been set correctly, then firms face demand for their goods and services. They’re going to need to hire people.

Q: Great. How does that affect me?

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