What is the Federal Reserve? What role does it play? Who controls the Federal Reserve? What does the Federal Reserve do? How does the Fed affect interest rates? These are just a small sampling of questions that people ask everyday. The Federal Reserve is the Central Bank for the United States. As you can borrow money from a bank, the bank can borrow money from the Federal Reserve.

The Federal Reserve is also referred to as "The Fed".

Most every bank mirrors the Federal Reserve with the Prime or Fed Funds rate they publish. What happens then is when the Fed moves the Fed Funds Rate, banks move their prime rate as well.

Increases and decreases in the Fed Funds rate by the Federal Reserve can have significant effects on the rates of Adjustable Rate Mortgages after their fixed period is over.

The primary goal of the Federal Reserve is to keep inflation under control. An overheated economy can lead to inflation which, if left unchecked, will cause interest rates to skyrocket. Ironically, raising interest rates bit by bit keeps inflation under control and thus long term interest rates under control as well. Conversely, The Fed lowers interest rates to avoid recessions.

The main policy "The Fed" uses to control liquidity for banks is the adjustment of the federal funds "overnight lending rate". Banks are required to maintain certain levels of reserves for banking purposes. These funds can be borrowed from other banks which have excess reserves. The federal funds rate is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight. A reduction in the federal funds rate decreases the costs for a Bank to borrow money to meet their required depository reserves. The often is is referred to as a "loosening" as it is less cost prohibitive to lend money aggressively.

 

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