The Fed and interest rates explained

Katie Couric
Global Anchor

By Kaye Foley

For the past year, the Federal Reserve and Chair Janet Yellen have been hinting that an increase in interest rates could be coming soon. Six and a half years ago, the Federal Reserve lowered the rates to nearly zero when the U.S. economy hit a recession and needed a boost.

But on Sept. 17, at a press conference, Yellen said, “We discussed this possibility at our meeting. However, in light of the heightened uncertainties abroad and a slightly softer expected path for inflation, the Committee judged it appropriate to wait” to raise the interest rates. The Fed has decided against raising interest rates for now, which would have been the first increase in nine years. But there’s still a chance the rates may be hiked before the end of the year.

“Most participants continue to expect that economic conditions will make it appropriate to raise the target range for the federal funds rate later this year,” Chair Yellen said.

When the Fed does decide to raise the rates, its members are saying they believe the economy is strong enough to handle an increase, which is a way to keep inflation in check.

But wait — what is the Fed and how does it work?

The government has influence over the economy in two ways. There’s fiscal policy, when Congress and the president create legislation on taxes, which impacts regulation and government spending.

Then there’s monetary policy, and that’s where the Federal Reserve comes in.

The Fed is a government agency, but is independent and doesn’t need approval from the branches of government. President Woodrow Wilson signed the Federal Reserve Act in 1913 as a way to centralize and regulate banking to prevent economic collapse. As the nation’s central bank, the Fed supervises other banks to keep people’s money safe.

The Federal Reserve studies economic trends and makes monetary policy decisions to keep things running smoothly — with the right amount of inflation and low unemployment levels — by regulating interest rates and the availability of money. For example, if the Fed wants to increase the money supply in the economy, it will tell banks to hold on to less, so they can lend more to businesses and people.

The Federal Reserve has a few ways of keeping the economy healthy, but one big influence is federal interest rates. When there’s little to no growth, the Fed encourages spending and hiring by lowering these rates. This means lower interest rates for the banks, which in turn can lead to lower interest rates for customers when it comes to loans, mortgage rates, and more.

When the economy is in good shape but at risk of too much inflation, the Fed increases the interest rates to keep things steady.

So if you’ve been waiting with bated breath to see whether the Federal Reserve would raise interest rates or not, at least after watching this video you can say, “Now I get it.”