Understanding The Fed and Its Impact on You

If you’ve ever flicked over to a financial news channel, you’ve probably heard the term “the Fed.” But who, or what, exactly is the Fed? And why does it matter to you?

Here, we explain the Federal Reserve System, or the Fed, and explore how its decisions can affect your everyday life.

What is the Fed?

“The Fed” stands for the Federal Reserve System, the USA’s central banking system. Created in 1913, it aims to stabilize the country’s financial system. Its key roles include managing monetary policy, ensuring financial stability, overseeing financial institutions, facilitating secure payments, and promoting consumer protection. ¹

The Fed has five general functions, including:

• Conducts the nation’s monetary policy
• Promotes the stability of the financial system
• Promotes the safety and soundness of individual financial institutions
• Fosters a safe and efficient payment and settlement system
• Promotes consumer protection and community development

The Fed also has dual objectives, often called the dual mandate: maximizing employment and keeping prices stable.² The first objective is to promote maximum sustainable employment, which translates to as many Americans having jobs as possible. The second objective is to maintain stable prices for the goods and services we purchase. In doing so, the Fed aims to foster a healthy economic environment where businesses can grow and people can build wealth.

How Often Does the Fed Meet?

The Federal Open Market Committee (FOMC) is the Fed branch responsible for making decisions about the money supply and interest rates and meets regularly to evaluate the economic conditions and adjust its policies accordingly.³ The FOMC meets eight times yearly (roughly every six weeks). It consists of twelve members: seven of the Board of Governors, the Federal Reserve Bank of New York president, and four rotating Reserve Bank presidents.

What Does the Fed Do?

The FOMC’s discussions and decisions significantly impact the nation’s economy. In the FOMC meetings, the Fed makes crucial decisions about monetary policy, especially around the federal funds rate (the interest rate at which banks lend to each other). This rate also indirectly affects other interest rates, such as those for mortgages, car loans, and credit cards, as well as the rates paid on savings accounts and money market funds.

The Fed also makes decisions about quantitative easing/tightening measures. Quantitative easing for example, involves the Fed buying government securities or other securities from the market to lower interest rates and increase the money supply, encouraging lending and investment. Quantitative tightening is the opposite, where the fed sells securities, or allows them  to mature to decrease the money supply.⁴

How the Fed Impacts You

Decisions made by the Fed directly impact the average investor. When the Fed raises or lowers interest rates, the cost of borrowing and the return on savings and investments are impacted. The ripple effects can influence many aspects of your portfolio.

When the Fed lowers interest rates, borrowing becomes cheaper, leading to increased spending by consumers and businesses. This surge in demand can boost the economy and potentially lead to higher stock prices. However, lower interest rates mean savers and bond investors earn less on their money, which can push them to look for higher returns and buy riskier investments.

Conversely, borrowing becomes more expensive when the Fed raises interest rates, often slowing economic activity. This can lead to lower stock prices, as businesses might see their revenue decrease, and consumers may cut back on spending. However, savers and bond investors can benefit from higher interest rates as they earn more on their investments.

The Fed plays an instrumental role in steering the nation's economic course. Its decisions affect not only big businesses and banks but also the average American and their financial future. By understanding the workings of the Fed and its influence on the economy, individual investors can make more informed decisions about their investments.