The U.S. Federal Reserve’s monetary policy has far-reaching effects—with its responsibility for setting short-term U.S. interest rates, it has the power to affect transactions and investments with any country or company doing business with the U.S. Its decisions can also affect your daily life—both directly (setting interest rates for mortgages, car loans, credit cards and more) and indirectly (influencing global economic conditions). It’s because of the consequences to businesses and individuals alike that the Fed’s Dec. 15 meeting is so highly anticipated.
Fed’s Dual Mandate
The Fed is comprised of three components – the Board of Governors, the regional Reserve Banks and the Federal Open Market Committee (FOMC) – which operates independently of the federal government. It has a dual mandate: maximize employment and maintain stable prices (i.e. control inflation). The Fed meets this obligation through monetary policy and controlling the nation’s money supply. This process becomes most visible through the actions of the FOMC.
FOMC Sets Rate Policy
The FOMC typically meets eight times a year to examine and discuss the economic and financial environment, as well as whether changes to the Fed’s monetary policy positions are warranted. FOMC meetings and the resulting policy statements are watched closely by financial markets around the globe; even the anticipation of policy changes can affect economic conditions and market performance.
During each meeting, the committee decides whether to change the Fed’s target for the federal funds rate, which is an interest rate that banks charge for overnight loans to one another. It’s an important benchmark for short-term interest rates. The Fed manages the actual federal funds rate around its target by, in part, buying and selling government securities that constitute bank reserves. Buying securities drives down the federal funds rate, while selling sends it higher.
Effects of FOMC Policy
Federal funds rate moves and other forms of monetary policy, such as bond purchases for the Fed’s own account (also known as “quantitative easing”), are intended to stabilize the U.S. economy by countering prevailing economic conditions. Lower interest rates are intended to stimulate the economy – and fuel inflation – by encouraging borrowing and spending. Higher interest rates are designed to restrict economic growth and inflation by increasing borrowing costs and encouraging spending cuts.
Changes in Fed interest rate policies can affect your investments, though not always in ways you might expect. The FOMC has to carefully weigh what impact its policies might have on foreign exchange, import prices, overseas earnings for U.S. companies, growth of emerging markets and a host of other interest rate-related ramifications.
Learn more about how to evaluate and manage the interest rate risk to your investments.