Description
Transcript
The Fed or Federal reserve system is at the centre of the American economy.
The Fed is basically a bunch of banks with two official goals and one sort of secret one.
The first?
Promoting job growth and maximising employment.
This is because an employed economy is a strong economy.
Employed folks spend money which fuels growth.
More jobs means more spending.
The second Fed mandate?
Controlling prices: making sure they don’t fall or rise too quickly.
This is basically controlling inflation.
And finally, in the last two decades the Fed has taken on a sort of hidden third task, which is supporting financial conditions that keep markets and the economy running smoothly.
For consumers, that means keeping stock and bond markets stable so consumers don’t panic.
These are the Fed’s three main goals – what they’re attempting to do.
Now let’s talk about the four tools they use to try and pull it off.
One: The rate lever.
The Fed can increase or decrease the Federal funds rate which is a big contributor to loans and savings account rates.
Higher rates encourage people and businesses to save their money, instead of spend it.
More saving means less demand, means less job growth.
But when people save, cash becomes more scarce which can help control inflation.
Two: The balance sheet lever.
The Fed can also step into the open market and buy or sell assets, like treasuries or mortgage-backed securities.
By purchasing these assets the Fed helps calm panic and tries to restore market confidence in them.
When the Fed buys assets, it’s essentially putting more cash into the financial system which can make its way into governments and businesses.
Three: The reserve ratio lever.
In normal times, the Fed makes banks keep a certain amount of cash and deposits relative to the amount of money they lend out.
The Fed can increase or decrease this ratio.
A higher ratio means banks need to keep more on hand, which means they have less cash to lend which means, for everyone else, it becomes harder and more expensive to get a loan.
By increasing the ratio, the Fed can control how fast money is moving around the economy.
This, too, can help slow down inflation.
Four: The microphone.
Over the past two decades the Fed has realised it has a powerful tool in its own words.
These days we’ve seen several Fed governors regularly make public statements about policy, whether it’s upcoming, current, or just hypothetical.
Seriously, sometimes the Fed likes to make an announcement, see how it lands, read the economic room so to speak, and make decisions based on the input they’re getting.
The Fed knows its words can calm markets and restore confidence if they talk about plans for policy.
It’s a dose of certainty in uncertain times, without the need to actually change policy.
Now that you know the Fed’s two main mandates, its hidden mandate, and the four tools it uses – the rate lever, balance sheet lever, reserve ratio lever, and microphone – you have a simple but thorough understanding of the Fed’s goals and how it tries to achieve them.