The U.S. Federal Reserve Board once again last month raised the so-called Fed Funds Rate that our central bank charges lending institutions on overnight loans. Who cares?
What we hear in the press centers on speculation as to how the Fed economists and governors are thinking in terms of further rate hikes, and what the impact will be (or not be) on inflation and the prospects of a recession.
But why should we non-economists care about this rate? Well, perhaps the most direct impact on us is the return we enjoy on short-term savings, vehicles, and cash. Not long ago, before the Fed decided to attack inflation, people were earning around half a percent a year on their money market funds and short-term bonds and CD’s. Today, it’s possible to shop for between one- and five-year maturities yielding five percent or more.
Another reason to care about this rate is credit card debt. When the Fed raises this rate, credit card issuers raise their rates accordingly. We are up to interest rates on credit cards of 20 percent a year on carried balances. Auto and personal loan lenders also charge higher interest rates, and most of us have watched mortgage rates move higher in loose lockstep with the Fed.
The reason the U.S. central bank moves these rates up or down is directly tied to the behaviors they wish to influence among all of us. Right now, the Fed economists are using these rate hikes in an effort to encourage us to save and invest more, and to discourage us from spending and borrowing – basically trying to cool off the pace of the economy, and reduce the demand for goods and services that cause inflation to remain higher than they’d like.
In this effort to influence public behavior, the Fed is not alone. The European Central Bank also raised its equivalent rate by a quarter of a percent, as did the Bank of Canada in July. Bottom line: this series of rate hikes has savers and investors rejoicing, while spenders and borrowers despair. How each of us cares about the Fed Funds Rate therefore, depends wholly upon which of these two camps we find ourselves most closely related to.
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