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The Federal Reserve

The Federal Reserve



How Banks Create Money

Out of Thin Air

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 Ways the Federal Reserve Affects You and Your Money


1. Mortgage rates
The interest rate you pay on your mortgage is probably the most well-known way the Fed can affect your pocketbook. Mortgage rates closely follow the yield of 10-year U.S. Treasury bonds, so if the Fed wants to influence rates, all it has to do is adjust the discount rate up or down (remember, a higher discount rate should stifle lending practices among banks), or move its federal funds target rate up or down. Since 2009, the Fed's policy of keeping the federal funds rate target at record low's has allowed homeowners to refinance or purchase homes at some of the lowest interest rates we've seen in decades.

2. Auto loan rates
Another common way the Fed influences your big purchasing decisions is through the federal funds rate, which is the overnight lending rate that banks charge when lending between one another. The 10 largest U.S. banks collectively set the prime rate, or the lowest rate commercial customers are charged, off of the movement of the federal funds rate.

The federal funds rate, and the prime rate, are also critical in setting auto loan rates. Typically, auto loan rates move up or down in tandem with the prime rate. If the Fed wishes to effect change on the prime rate, it can do so by purchasing or selling short-term U.S. Treasuries.

3. Credit card rates
You're probably noticing a trend by now, but the credit cards in your wallet are intricately tied to the movements of the Fed. Based on the Federal Reserve's movements in short-term U.S. Treasuries, the federal funds rate and the prime rate help lenders determine what they'll charge consumers in interest on their credit card. A rising federal funds target rate should lead to a rising prime rate, and thus a higher interest rate charged to variable rate credit card holders.

4. The price of goods and services (indirectly)
The Fed's control over the money supply can also have an indirect correlation to the price you pay for everything from a $4,000 couch to a $1.99 stick of butter.

For example, during a recession (and as we witnessed during quantitative easing programs) the Fed may choose to increase the money supply at a more rapid pace than normal to spur lending. This increases the supply of money and it encourages consumers to spend. Increasing the money supply, if the economy is in good shape, can also make it easy for businesses to raise prices, thus leading to inflation. Some inflation is typically optimal, but high levels of inflation would be bad news for the U.S. economy.