I am quite certain the topic of a fed rate has the potential to bore a lot of people right into the next article. But I also know most of you probably heard the news of the Federal Reserve raising its interest rate a couple weeks ago.
You wondered for a brief second exactly what that was, and then went on to the next subject. So, in an effort to do my part as a very part-time journalist, I’ll give everyone a brief explanation of what the Fed rate really is and does.
The Federal Reserve as we know it was created in 1913 in reaction to the Panic of 1907. It acts as the great stabilizer of U.S. currency.
When banks run out of money, they can go to the Federal Reserve. In 1907 there was a run by people withdrawing money from banks so they could invest in the stock market.
John Pierpont Morgan convened New York’s leading bankers in his personal library and persuaded them to meet all the demands for cash. To prevent this from happening again, Congress created the Federal Reserve.
At first, the Fed didn’t consider itself as an active influencer of the economy. It simply was there to lend money to banks, paid back with interest.
It wasn’t until the late 1920s that it moved those interest rates with the intent of affecting the economic behavior of businessmen and women.
Today, all of our major U.S. banks store money at the Federal Reserve. And they all receive interest from the Fed, just as you would from a basic savings account.
This interest rate is essentially what the national news outlets are referring to when they talk about the Fed raising its interest rate. And they report this because it has a tremendous effect on each bank’s balance sheet and in turn how the bank’s charge or compensate you for accounts you hold with them.
For example, if the bank earns more interest from the Fed on money it stores there, then it can give you more interest on your savings accounts that you have with them.
Conversely, if your banks get charged more for money it borrowed from the Fed, or more accurately, from other banks who use the Fed’s rate as a benchmark, it will charge you a higher interest rate on money it lends to you in the form of a small business loan, home equity line of credit or mortgage.
The recent news was the Fed raised this rate to between 0.75 percent and 1 percent. Why is it between two numbers? What does that mean?
Well, it’s not quite that simple. While it does set a rate, that rate moves based on the Fed’s actions to increase or decrease the overall supply of money – which affects its value, as well as the interest rate.
The last part of that explanation is a little complex, but the important thing to see here is that the Fed is raising its rates.
As mentioned earlier, the Fed uses this rate to manipulate, as best it can, the economy.
After the financial crisis of 2008, banks, like everyone else, had very little faith in our economy. So they didn’t want to lend their money to businesses that may not be able to repay that loan.
They recoiled and stored their money at the Federal Reserve. In an effort to get banks lending, and money flowing in the economy, the Fed reduced its rate to near 0 percent. The Fed knows that banks want their money working, or earning more money.
Instead of earning nothing by storing their money in the fed, they would feel pressured to take a harder look at their loan applicants.
So the Fed decision to raise rates means that its governors believe our banks are confident in the economy enough to lend moneyover and above what it can earn at the Federal Reserve.
Speaking as someone who was hit hard during the 2008 crisis, this is very welcoming news. I hope it lasts.