Remember how some Savings Accounts rates were reaching almost 3% APY? Seems like it was just last week, while now you’re lucky if you have 1.8% percent. Aren’t you curious about how, and more importantly - why that happens? No worries, since this is when the fed and interest rates explained! This is like a Federal Reserve crash course today, or a quick "federal reserve and you" training.
Interest rates are nearly zero since the 2007 financial crisis. The good news are that the loans are cheaper, so it's cheaper to buy stuff. As US economy improves, the Fed will raise interest rates. This is when The Fed and your interest rates get connected. The Federal Reserve System is what influences the Interest Rate of your Savings. It is also often called as "The Fed". The Fed determines the national monetary policy, or in other words, The Fed determines how much money is floating around in the US economy. The key decisions are made by the Federal Open Market Committee, which holds meeting at least 4 times per year, and the notes from their meeting are publicly available. By controlling the money supply, the Fed is able to control the interest rates, which translates into overall health of the economy. The 2 main things The Fed is watching for are Inflation and Unemployment. There are multiple tools the The Fed uses to keep everything under control, but the main thing that we all need to be aware of is the Federal Funds Rate, also known as “benchmark rate". The Federal Funds Rate is the rate that banks charge each other to meet their Reserve Requirements. And the Reserve Requirement is the minimum amount of money that the bank must hold in reserve to protect itself from failure. When some bank is short on cash to meet its Reserve Requirement, it can borrow money overnight from another bank at the Federal Funds Rate, or from The Federal Bank itself at Discount Rate. Discount Rate is what the Federal Reserve Bank charges for overnight loans, and which basically controls the Federal Funds Rate. So, if The Fed decide that the economy needs stimulation, they announce lower "Target Federal Funds Rate", and then actually lower Discount Rate, which pressures banks to lower their effective Federal Funds Rate to hit the target. As you can see, The Fed Discount Rate is closely related to the Federal Funds Rate, and by influencing the Federal Funds Rate, The Federal Reserve also influences other short term rates.
What does all that mean for YOU?
The lower interest rates mean that it's cheaper to borrow and less attractive to save. That's also why stock market gets so happy when The Fed announce lowering rates. Lower rates also means cheaper house loans, cheaper business loans, which in turn means more jobs, economy expansion and happier people.
But the economy growth also means Inflation. Inflation is the rising cost of goods and services. Little Inflation is good for the economy, but if you just keep your money under your mattress, it just loses its value! That’s why its important to keep your money at least *some* interest in Savings Account! Consider investing some of the money long term to increase the average return over years.
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