Weekend Read - How the Fed Fights Inflation
Inflation has been a hot topic lately, and many of you might be wondering how the Federal Reserve (the Fed) tries to keep it under control. It's a complex task, but the Fed mainly uses two powerful tools: adjusting interest rates and buying or selling U.S. Treasury securities. Let's break down how these work.
Adjusting Interest Rates
The Fed controls the federal funds rate, which is the interest rate at which banks lend to each other overnight. This rate influences many other interest rates, affecting everything from mortgages to car loans to credit card rates. When the Fed lowers interest rates, borrowing becomes cheaper for consumers and businesses. This can boost spending and investment, helping to grow the economy. On the flip side, raising rates makes borrowing more expensive, slowing down spending and cooling off an overheating economy. Lower interest rates mean lower financing costs for big-ticket items like homes and cars, encouraging consumers to spend more and giving the economy a lift. With cheaper loans, businesses are more likely to invest in new projects, expand operations, and hire more workers, further stimulating economic activity. Raising interest rates does the opposite. The raising and lowering of interest rates has an immediate impact on the market.
Open Market Operations (Buying or Selling Treasuries)
The Fed also manages the money supply in the economy through open market operations, which involve buying or selling U.S. Treasury securities. When the Fed buys U.S. Treasury securities, it injects money into the banking system. This increases the money supply, lowers interest rates, and promotes lending and spending. Increased spending can stimulate economic growth, which is beneficial during periods of low inflation or economic downturns. Conversely, when the Fed sells U.S. Treasury securities, it pulls money out of the banking system, reducing the money supply. This can lead to higher interest rates, making borrowing more expensive and slowing down spending and investment. This reduction in spending can help control and reduce inflation. The open market activity has a greater impact on long-term interest rates.
Recent Actions by the Fed
Recently, the Fed has been actively managing interest rates to tackle high inflation. Over the past year, they have increased rates several times to slow down the economy and bring inflation under control. Currently, we are in a holding pattern as the Fed waits for sufficient economic data to confirm that inflation is on a sustainable downward path. They want to ensure that lowering rates too soon won't cause inflation to spike again. This cautious approach means they are closely monitoring various economic indicators before making any further moves.
By carefully adjusting these tools, the Fed aims to strike a balance between supporting economic growth and keeping inflation in check. The goal is to achieve stable prices and maximum employment, which are the dual mandates of the Federal Reserve.
Enjoy your weekend and stay tuned for more insights next week!
Best,
Jeremy Raffer, MBA
Director & Partner - Financial Advisor
m. 201-747-2705
e. jeremy.raffer@stewardpartners.com
Steward Partners Global Advisory, LLC
Country Club Plaza
115 W. Century Rd, Suite 145
Paramus, NJ 07652
The views expressed herein are those of the author and do not necessarily reflect the views of Steward Partners or its affiliates. All opinions are subject to change without notice. Neither the information provided nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Past performance is no guarantee of future results.
Information contained herein has been obtained from sources considered to be reliable, but we do not guarantee their accuracy or completeness.
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