How the Fed Steers Interest Rates to Guide the Entire Economy | WSJ
How the Fed Steers Interest Rates to Guide the Entire Economy | WSJ
The Federal Reserve’s main tool for managing the economy is to change the federal funds rate, which can affect not only borrowing costs for consumers but also shape broader decisions by companies like how many people to hire. WSJ explains how the Fed manipulates this one rate to guide the entire economy. Illustration: Jacob Reynolds
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0.37 -> - [Narrator] With
inflation hovering around
1.67 -> its highest rate in 40 years,
3.65 -> the Federal Reserve is expected
to raise interest rates
6.33 -> several times in 2022.
9.14 -> This is Fed chairman Jerome Powell
11.03 -> on what will be needed to ensure
a long economic expansion.
14.59 -> - That's gonna require the Fed
16.41 -> to tighten interest rate policy
18.28 -> and do our part in getting
inflation back down
21.64 -> to our 2% goal.
23.1 -> - [Narrator] The way the
central bank does this
24.57 -> is by changing the federal funds rate,
27.01 -> its main tool for managing the economy.
29.5 -> You can see on this chart
that the rate was lowered
31.93 -> to nearly 0% in 2020 to boost the economy
35.13 -> at the beginning of the pandemic.
36.8 -> - There is an important
job for us to move away
39.7 -> from these very highly simulative
monetary policy settings.
44 -> - [Narrator] Adjustments
to the federal funds rate
45.61 -> influence a range of borrowing costs,
47.94 -> from how much you own your
credit card to mortgage rates.
51.11 -> They also shape broader
decisions made by companies,
53.6 -> like how many people to hire
or whether to raise prices.
57.02 -> Here's how the federal funds rate works
59.32 -> and how just one rate can
guide the entire economy.
69.03 -> - The Fed meets every six or so weeks,
71.89 -> and they're looking at
a range of economic data
74.02 -> at those meetings,
75.34 -> but they have two main goals.
76.93 -> One is to ensure stable
prices and low inflation.
81.18 -> And the other is to make sure
82.063 -> that the layer market is strong.
84.2 -> - [Narrator] Nick Timiraos
covers how the fed guides
86.23 -> the economy through crises.
87.68 -> He says, you can think of the economy
89.13 -> as a car and the fed as the driver.
91.75 -> - They wanna make sure
92.583 -> that the economy's not growing too slow.
95.11 -> And when it is, they'll push on the gas
97.15 -> but they also wanna make sure
that it's not going too fast.
99.99 -> And so they'll slow the economy down
101.92 -> by pressing on the break.
103.62 -> - [Narrator] This is where the
federal funds rate comes in.
105.8 -> - When you hear on the news
106.9 -> about the fed raising interest rates
108.91 -> or cutting interest rates,
110.37 -> what they're actually deciding to do
112.41 -> is to raise or to lower
the federal funds rate.
116.1 -> - [Narrator] This is the interest rate
117.19 -> that banks charge each other
to borrow money overnight,
120.25 -> but there's a catch.
121.73 -> The federal funds rate
122.563 -> isn't directly set by the federal reserve.
125.51 -> So in order to influence it,
127.14 -> the fed uses a couple of other
tools to set a target range.
130.68 -> These tools are rates that
the fed controls in its role
133.46 -> as a bank for banks.
135.06 -> Here's the target range that
was in place during 2021.
138.52 -> The federal reserve sets an
upper limit and a lower limit
141.61 -> with the goal of keeping the
effective federal funds rate
144.15 -> somewhere in between.
145.68 -> The upper limit is determined
147.29 -> by interest on reserve balances.
149.36 -> This is the rate of interest
a bank gets on deposits
152.19 -> known as reserves that it
keeps at the federal reserve.
155.31 -> The lower limit is determined
156.71 -> by overnight reverse repurchases.
158.91 -> These are securities like treasury bills,
161.08 -> but the federal reserve lends
to banks usually for a day
164.22 -> while paying interest.
166 -> On this chart, you can see where the fed
167.85 -> has set the target range
between the two yellow lines,
170.83 -> the blue line, which is the
effective federal funds rate
173.41 -> set by banks sits between
the upper and lower limits
176.57 -> as the target range changes
178.14 -> the effective rate goes up or down with it
180.96 -> - So far they've had
very successful control
183.69 -> over guiding the federal funds rate
185.71 -> and guiding all short-term
money market rates
188.78 -> to where they generally
are trying to move them.
192.33 -> - [Narrator] The fed
makes these adjustments
193.66 -> in fairly small increments.
195.4 -> Its rate increases for 2022
are expected to only change
198.81 -> by about a quarter to
half of a point at a time.
202.1 -> So how can these tiny
adjustments for banks
204.1 -> help cool down the entire economy?
207.2 -> It all has to do with how those rates
209.04 -> ripple through the system.
210.45 -> As banks are charged more to borrow,
212.51 -> they'll in turn charge
their customers more,
214.63 -> affecting the cost of existing loans
216.57 -> and demand for new borrowing.
218.98 -> The goal of raising these
rates is to drive down demand.
222.62 -> - Inflation results when supply
and demand are outta whack.
225.84 -> The fed can't do anything to
increase the supply of oil
229.71 -> or to increase the number
of houses for sale.
232.59 -> The supply side is something
out of their reach,
235.07 -> but they can bring supply and
demand by reducing demand.
239.69 -> - [Narrator] Here's how
rates can influence demand
240.93 -> and inflation.
242.16 -> When rates are low, more
people in businesses
244.4 -> are likely to take out loans.
246.32 -> Higher demand for goods and services,
248.22 -> as well as lower rates allows employers
250.61 -> to open more positions to meet demand
252.84 -> and raise wages to appeal
to potential employees.
255.97 -> Consumers then turn around
257.4 -> and spend those wages
on goods and services,
259.74 -> which in turn can lead to
more jobs and higher prices.
262.95 -> The opposite happens
when rates are higher.
265.4 -> Fewer people and
businesses take out loans,
267.71 -> job growth slows, and spending decreases.
271.06 -> Higher interest rates may
also make it more appealing
273.35 -> to save.
274.21 -> Inflation slows as supply
and demand balance out.
277.95 -> While interest rates can be effective
279.52 -> in bringing inflation down,
281 -> a rate hike could take some
time to make an impact.
284.29 -> - Think about your own life
285.47 -> as you go through making
different decisions
287.37 -> about whether to buy a house
and how big of a house to buy.
289.66 -> It may take a while for this
291.08 -> to ripple through the
housing market, for example,
293.86 -> but in 6 or 12 months, we
could begin to see, you know,
297.41 -> less demand if interest
rates are high enough
299.99 -> to slow interested consumers.
303.383 -> - [Narrator] But while inflation
may take time to come down,
305.43 -> consumers and businesses
will likely feel the impact
308.28 -> of higher interest rates
on loans, mortgages,
311.14 -> and credit cards right away.
Source: https://www.youtube.com/watch?v=AkMsMDk_brU