You know how the adults usually mention the economy when they talk about them on the news? They may indicate that it is becoming slower or getting hotter. It may appear to be a big, unseen clockwork. However, what do you think should I mention to you that there are a few people in Washington, D.C., who have an incredibly important task: they are the ones who regulate the volume knob of the economy.
This is known as the Federal Reserve or abbreviated as the Fed. It is not that they have everything but have one instrument of superpower. This instrument is referred to as the federal funds rate. We will go on an adventure today to learn about this tool. We shall respond to the big question: What are Fed rate cuts and why do we care? Let's make this simple and fun!
What Are Fed Rate Cuts and Why Do They Matter? The Simple Breakdown
Visualize the whole U.S economy as a giant automotive. At other times, the automobile is excessively fast (prices grow fast). In other instances, it is too slow (people lose jobs). The Fed is like the driver. The driver employs the brake and the gas pedal to regulate the speed of the car. Reduction of Fed rates is similar to pressing gas pedal softly. It accelerates the car (the economy).
The Super Short Explanation of the Federal Funds Rate
The federal funds rate is merely a rate of interest. It is the rate that the banks lend out each other at very short-term rates.
Consider it in the following way: You possess a piggy bank. Your friend has asked you to loan him a day. You could tell me, all right, but you must refund me a penny tomorrow. The additional penny is interest.
The Fed establishes benchmark on the size of that additional penny as big banks lend to each other on short-term basis. This may appear to be an insignificant thing, yet, it is similar to a rock falling on the pond. The ripples disseminated all!
What or Who is the Federal Reserve?
The central bank of the United States is the federal reserve. It is not just one building, it is an entire system. It is primarily mandated to maintain our economy in a healthy state.
Imagine the Fed to be the coach of the U.S. economy. The coach is not the one playing the game but he calls the plays to enable the team to win. The Fed's two main goals are:
The Ripple Effect: The One Change in rates that affects your life
You might think, "I'm not a bank! Why will I bother what banks will charge each other? Great question! Almost all the other interest rates in the country are based on that initial rate of interest between banks. It is the initial and largest splash in the pond.
Fed Rate Cuts: How to make the money cheap to borrow
When the Fed reduces its rate, it sends the message to the world that money borrowing is now cheap. This is the gas pedal effect.
And how this will fare you and yours:
Behind the Curtain: Savers and Rate Cuts
Now, there is another side. But what can you do when you are a saver and not a borrower?
Reduced Savings Account Yields: In the event that you have money in a savings account, the bank pays you interest. This is called your yield. In case of Fed rate reduction, the interest that you receive in your savings account tends to decrease. Your money grows more slowly. This is the trade-off.
Hence, a decrease in the rate is usually a good news to the borrowers and a damping news to the savers.
Why would Fed choose to lower the rates?
Fed does not lower interest rates to play around. They have particular motives as to why they do it. It is like the doctor prescribing medicine when the patient is already ailing. The following are the primary factors that may make the Fed press the economic gas pedal:
To Stimulate a Stagnant or Underperforming Economy
The economy at times appears weary. Individuals cease spending so much money. Businesses stop hiring. At times, individuals are laid off. This is referred to as an economic slowdown or even recession. In this case, Fed is able to reduce the rates in order to motivate individuals and companies to borrow and spend money. This assists in jump starting the economic engine.
To Fight High Unemployment
When the number of unemployed individuals is high and they are unable to secure employment, then it is not encouraging. Among the core roles of Fed is to contribute towards the creation of maximum employment conditions. They lower the rates thereby making it easier to borrow money and hire new personnel, purchase new equipment and construct new factories by the companies. This would aid in reinstating people to work.
To control inflation (Being Cautious)
This one is tricky. The Fed must also ensure that it avoids inflation-where prices of commodities such as food, gas and toys increase at an unreasonable rate. Typically, Fed increases interest rates in order to combat inflation. However, there are cases when they believe that inflation has got too low, a rate cut can be used to push it to a healthy level. It's a constant balancing act!
Real-Life Applications: The Rate Cuts in Practice
We will bring this closer to reality with a story
A Case Study: Maria Pizza Shop and the Cut in the Rate.
Maria is the owner of a pizza shop called Maria magnificent pizza. Business is alright, but it is decelerated. Individuals are not ordering so much. She dreams of having an ice cream counter to bring more families on board.
In order to accomplish this, she requires a small business loan to purchase a freezer and supplies.
Her business expands, two individuals have new employment, and the town has a new source of getting dessert. This is what can happen when one rate cut will make a good ripple effect in a community.
The Bigger Picture: What the Rate Cuts Should and Shouldn’t do to the Stock Market and Your Wallet.
Fed rate cut has even further impacts
The Relationship between Stock Market and Interest Rates
Have you heard about the stock market? It is where humans are able to purchase small portions (so-called shares) of large corporations, such as Apple or Toyota. When the savings account interest rates are too low, individuals are not making much money by leaving their money in the bank. That is why they seek other locations to invest their funds. They tend to invest it in the stock market. Such demand may lead to an appreciation of the stock prices. Thus, in most cases (though not necessarily at all), the lower the rates that the Fed sets, the higher the stock market.
How It Affects Your Family Budget?
Let's bring it all home. What does this immediate touch your life?
Fed rate cuts are effective and yet not magic wand. There can be downsides.
The Risk of Rising Inflation
When the Fed stomps on the gas pedal excessively and excessively, it may lead to overheating of the engine. To an economist, this translates to excess money in pursuit of scarce goods. This has the potential of causing rapid increase in prices thus resulting in high inflation. When that occurs, then the Fed will be forced to slam brakes (increase rates) in order to cool it down.
The reason why savers may be frustrated
At least, according to what we were told, individuals who depend on interest on their savings experience a decrease in the income. This may be difficult to retirees who depend on such money to settle their bills.
Can Rate Cuts Create Bubbles?
Very cheap interest rates over very long periods of time can lead to the tendency to borrow money too easily. This may make individuals spend on risky items which may lead to the existence of bubbles in commodities such as housing or technology shares which might burst.
Conclusion
So, let's review. What are Fed rate cuts and why are they important? Fed reduction refers to the decrease in the central interest rate of the U.S central bank. It is as though you were putting your gas pedal on the economy to accelerate. It is important in that it will ensure that more people including families purchasing houses as well as businesses expanding and hiring can borrow money cheaply.
This is such a strong instrument, which influences your savings, loans of your family, and health of the whole national economy. The next time a news journalist tells you that the Fed is thinking about lowering the rates, you will understand what he/she means. You will make your friends and family members impressed with your explanation of the volume knob in the economy!
FAQs
Q1: Does the Fed increase or lower the rates?
The Fed is convened to determine rates eight times in a year. They do not transform them each time. They may attend a number of meetings without the change, or they may make changes a number of times sequentially in case the economy requires it.
Q2: Does the reduction in the rate imply that the economy is not okay?
Not always. At times it is a precautionary step to maintain a healthy economy in a healthy state. At other times it is a direct attack on indications of weakness. The Fed tries to be proactive.
Q3: Who is the rate announcer?
Chair of the Federal Reserve is the one who announces the official announcements. This individual resembles the coach of the team talking at the press conference. People all over the world examine their words with a lot of care!
Q4: Is it only in the United States that rate cuts are done?
No! Nearly all countries have a central bank (such as the European central bank or the bank of Japan). All of them utilize the same tools to operate their respective economies.
Q5: Where can I get to know about the recent Fed decision?
This news is available on the large financial websites, television news and the official Federal Reserve site.
Read Also : Beautiful Hollywood Teens | 10 Underrated Young Stars Who Shine Bright
Gianna Eleanor
You know how the adults usually mention the economy when they talk about them on the news? They may indicate that it is becoming slower or getting hotter. It may appear to be a big, unseen clockwork. However, what do you think should I mention to you that there are a few people in Washington, D.C., who have an incredibly important task: they are the ones who regulate the volume knob of the economy.
This is known as the Federal Reserve or abbreviated as the Fed. It is not that they have everything but have one instrument of superpower. This instrument is referred to as the federal funds rate. We will go on an adventure today to learn about this tool. We shall respond to the big question: What are Fed rate cuts and why do we care? Let's make this simple and fun!
What Are Fed Rate Cuts and Why Do They Matter? The Simple Breakdown
Visualize the whole U.S economy as a giant automotive. At other times, the automobile is excessively fast (prices grow fast). In other instances, it is too slow (people lose jobs). The Fed is like the driver. The driver employs the brake and the gas pedal to regulate the speed of the car. Reduction of Fed rates is similar to pressing gas pedal softly. It accelerates the car (the economy).
The Super Short Explanation of the Federal Funds Rate
The federal funds rate is merely a rate of interest. It is the rate that the banks lend out each other at very short-term rates.
Consider it in the following way: You possess a piggy bank. Your friend has asked you to loan him a day. You could tell me, all right, but you must refund me a penny tomorrow. The additional penny is interest.
The Fed establishes benchmark on the size of that additional penny as big banks lend to each other on short-term basis. This may appear to be an insignificant thing, yet, it is similar to a rock falling on the pond. The ripples disseminated all!
What or Who is the Federal Reserve?
The central bank of the United States is the federal reserve. It is not just one building, it is an entire system. It is primarily mandated to maintain our economy in a healthy state.
Imagine the Fed to be the coach of the U.S. economy. The coach is not the one playing the game but he calls the plays to enable the team to win. The Fed's two main goals are:
The Ripple Effect: The One Change in rates that affects your life
You might think, "I'm not a bank! Why will I bother what banks will charge each other? Great question! Almost all the other interest rates in the country are based on that initial rate of interest between banks. It is the initial and largest splash in the pond.
Fed Rate Cuts: How to make the money cheap to borrow
When the Fed reduces its rate, it sends the message to the world that money borrowing is now cheap. This is the gas pedal effect.
And how this will fare you and yours:
Behind the Curtain: Savers and Rate Cuts
Now, there is another side. But what can you do when you are a saver and not a borrower?
Reduced Savings Account Yields: In the event that you have money in a savings account, the bank pays you interest. This is called your yield. In case of Fed rate reduction, the interest that you receive in your savings account tends to decrease. Your money grows more slowly. This is the trade-off.
Hence, a decrease in the rate is usually a good news to the borrowers and a damping news to the savers.
Why would Fed choose to lower the rates?
Fed does not lower interest rates to play around. They have particular motives as to why they do it. It is like the doctor prescribing medicine when the patient is already ailing. The following are the primary factors that may make the Fed press the economic gas pedal:
To Stimulate a Stagnant or Underperforming Economy
The economy at times appears weary. Individuals cease spending so much money. Businesses stop hiring. At times, individuals are laid off. This is referred to as an economic slowdown or even recession. In this case, Fed is able to reduce the rates in order to motivate individuals and companies to borrow and spend money. This assists in jump starting the economic engine.
To Fight High Unemployment
When the number of unemployed individuals is high and they are unable to secure employment, then it is not encouraging. Among the core roles of Fed is to contribute towards the creation of maximum employment conditions. They lower the rates thereby making it easier to borrow money and hire new personnel, purchase new equipment and construct new factories by the companies. This would aid in reinstating people to work.
To control inflation (Being Cautious)
This one is tricky. The Fed must also ensure that it avoids inflation-where prices of commodities such as food, gas and toys increase at an unreasonable rate. Typically, Fed increases interest rates in order to combat inflation. However, there are cases when they believe that inflation has got too low, a rate cut can be used to push it to a healthy level. It's a constant balancing act!
Real-Life Applications: The Rate Cuts in Practice
We will bring this closer to reality with a story
A Case Study: Maria Pizza Shop and the Cut in the Rate.
Maria is the owner of a pizza shop called Maria magnificent pizza. Business is alright, but it is decelerated. Individuals are not ordering so much. She dreams of having an ice cream counter to bring more families on board.
In order to accomplish this, she requires a small business loan to purchase a freezer and supplies.
Her business expands, two individuals have new employment, and the town has a new source of getting dessert. This is what can happen when one rate cut will make a good ripple effect in a community.
The Bigger Picture: What the Rate Cuts Should and Shouldn’t do to the Stock Market and Your Wallet.
Fed rate cut has even further impacts
The Relationship between Stock Market and Interest Rates
Have you heard about the stock market? It is where humans are able to purchase small portions (so-called shares) of large corporations, such as Apple or Toyota. When the savings account interest rates are too low, individuals are not making much money by leaving their money in the bank. That is why they seek other locations to invest their funds. They tend to invest it in the stock market. Such demand may lead to an appreciation of the stock prices. Thus, in most cases (though not necessarily at all), the lower the rates that the Fed sets, the higher the stock market.
How It Affects Your Family Budget?
Let's bring it all home. What does this immediate touch your life?
Fed rate cuts are effective and yet not magic wand. There can be downsides.
The Risk of Rising Inflation
When the Fed stomps on the gas pedal excessively and excessively, it may lead to overheating of the engine. To an economist, this translates to excess money in pursuit of scarce goods. This has the potential of causing rapid increase in prices thus resulting in high inflation. When that occurs, then the Fed will be forced to slam brakes (increase rates) in order to cool it down.
The reason why savers may be frustrated
At least, according to what we were told, individuals who depend on interest on their savings experience a decrease in the income. This may be difficult to retirees who depend on such money to settle their bills.
Can Rate Cuts Create Bubbles?
Very cheap interest rates over very long periods of time can lead to the tendency to borrow money too easily. This may make individuals spend on risky items which may lead to the existence of bubbles in commodities such as housing or technology shares which might burst.
Conclusion
So, let's review. What are Fed rate cuts and why are they important? Fed reduction refers to the decrease in the central interest rate of the U.S central bank. It is as though you were putting your gas pedal on the economy to accelerate. It is important in that it will ensure that more people including families purchasing houses as well as businesses expanding and hiring can borrow money cheaply.
This is such a strong instrument, which influences your savings, loans of your family, and health of the whole national economy. The next time a news journalist tells you that the Fed is thinking about lowering the rates, you will understand what he/she means. You will make your friends and family members impressed with your explanation of the volume knob in the economy!
FAQs
Q1: Does the Fed increase or lower the rates?
The Fed is convened to determine rates eight times in a year. They do not transform them each time. They may attend a number of meetings without the change, or they may make changes a number of times sequentially in case the economy requires it.
Q2: Does the reduction in the rate imply that the economy is not okay?
Not always. At times it is a precautionary step to maintain a healthy economy in a healthy state. At other times it is a direct attack on indications of weakness. The Fed tries to be proactive.
Q3: Who is the rate announcer?
Chair of the Federal Reserve is the one who announces the official announcements. This individual resembles the coach of the team talking at the press conference. People all over the world examine their words with a lot of care!
Q4: Is it only in the United States that rate cuts are done?
No! Nearly all countries have a central bank (such as the European central bank or the bank of Japan). All of them utilize the same tools to operate their respective economies.
Q5: Where can I get to know about the recent Fed decision?
This news is available on the large financial websites, television news and the official Federal Reserve site.
Read Also : Beautiful Hollywood Teens | 10 Underrated Young Stars Who Shine Bright