Federal Reserve and the Economy
By Saghir Aslam
Rawalpindi, Pakistan
( The following information is provided solely to educate the Muslim community about investing and financial planning. It is hoped that the Ummah will benefit from this effort through greater financial empowerment, enabling the community to live in security and dignity and fulfill their religious and moral obligations towards charitable activities)
You may have been hearing a lot lately about the Federal Reserve, better known the “Fed,” and its Chairman. You may also ready known that the Fed has an influence on interest rate, which in turn influences the economy. But there is more to the Fed that meets the eye, and the reason behind the interest rate changes may interest you as an investor. The fed was established in 1913 and consists of a seven-member board of governors, including the chairman.
All are appointed by the president and approved by the senate. The nation is divided into 12 Federal Reserve districts represented by 12 Federal Reverse banks, since its establishment, the Fed has become responsible for directing the nation’s monetary policy. The Fed also regulates the nation’s bank and other depository institutions and supervises directly many commercial banks. The Fed also tries to support other financial transactions. Although the Fed has many responsibilities, most investors only think of the Fed as having control over the interest rates that effect the US financial markets.
There are many different interest rates, but the Fed has direct control over only one of those interest rates. The discount is the interest rate the Fed charges its member banks on money borrowed for certain short-term loans. The Fed also has influence over the federal funds rate. The Fed funds rate is the rate for one bank to borrow form another. Banks keep money deposited with the Fed to meet the Fed’s reserved requirement. During a normal business day, a bank may end up with more or less in its reserves account than the required amount. If it has too little, it may borrow from other banks. If reserves are above the minimum, the bank can loan the excess to a bank that is below minimum. The market for Federal funds determines the federal funds rate.
By controlling the discount rate, the Fed can influence the nation’s economy cycles, to some extent. Let’s look at some scenarios: if the nation’s economy expands rapidly, historical the threat of inflations become a worry of consumers. Inflation- the great increases in the price of services and goods - lowers consumers purchasing power. The Fed fights inflation by increasing these key interest rates. By raising the fed funds rate, the Fed decreases the amount of money available to the national banking system. Banks tend to base the rates charged for business and consumer loans own their own cost of funds. So an increase in the discount rate fed funds rate will usually lead to banks increasing their leading rates. This makes borrowed money for certain more expensive for business and consumers. By making borrowed money more expensive, the Fed hopes to slowing down the rate at which money is spent.
When the economy is dragging and needs an extra monetary boost, the Fed “loosens” the nation’s money supply by decreasing the discount and fed funds rates. By lowering rates, the Fed makes more money available to the nation’s bank. This leads to borrowed money becoming cheaper for consumers and business. The extra money helps stimulate consumer spending and promote economic growth.
You may want to pay close attention to the actions of the Federal Reverse, especially if you may Interest sensitive investments. Your financial advisor can assist you in understanding how interest rate change can affect the performance of your portfolio.
(Saghir A. Aslam only explains strategies and formulas that he has been using. He is merely providing information, and NO ADVICE is given. Mr Aslam does not endorse or recommend any broker, brokerage firm, or any investment at all, nor does he suggest that anyone will earn a profit when or if they purchase stocks, bonds or any other investments. All stocks or investment vehicles mentioned are for illustrative purposes only. Mr Aslam is not an attorney, accountant, real estate broker, stockbroker, investment advisor, or certified financial planner. Mr Aslam does not have anything for sale.)
