What is the Fed? The role of the Fed in the global economy

The actions of the Fed (the US Federal Reserve) have a great influence on the world financial market markets and also on stock prices in each country. Therefore, understanding what the Fed is, its role, and capturing information from the Fed will help investors make flexible decisions when trading.

1. What is the Fed?

Fed is the Federal Reserve, which is the central bank of the United States. While the making of fiscal laws is delegated to three branches of government. The Fed sets monetary policy by adjusting interest rates, money supply and banking and regulations to promote economic stability.

Fed - Federal Reserve
Fed – Federal Reserve

The broader Fed system has three pillars: the board of governors, the 12 regional reserve banks, and the FOMC. The Washington Board of Governors is a seven-member board that oversees the entire Fed system. The president appoints each official, and they are then confirmed in the Senate.

On top of that, the Fed’s board has about 1,850 other staff members, all of whom conduct research on broader macroeconomic issues to help inform policymakers.

On the other hand, 12 regional Fed reserve banks are scattered throughout the country. Each bank has its own president and board of directors, who stay up-to-date on their region’s economy and report those findings to the board. Congress created these regional banks to ensure that the Fed is a “decentralized” central bank, which means the Fed doesn’t just care about what’s happening on Wall Street or Capitol Hill, but the Fed attention should be paid to all areas.

2. What does the Fed do?

Interest rate decisions of Fed attract the most attention. In FOMC meetings, officials have three options: Raise rates, lower rates, or keep them.

Think of the US economy at a speed limit. If it moves too fast, it runs the risk of “burning out”. As a result, the Fed will push the brakes by raising interest rates, which makes borrowing more expensive and essentially encourages consumers and businesses to delay purchases, slowing the economy.

Conversely, when the US economy faces a recession, the Fed will cut interest rates to support it. That drives more consumers and companies to buy those big tickets, back into the economy and act as a stimulus to growth.

Fed Chairman - Mr. Jerome Powell
Fed Chairman – Mr. Jerome Powell

The Fed has also occasionally lowered interest rates as the economy slows, in an effort to spur economic expansion. For example, in 2019, the Fed lowered interest rates for three consecutive meetings amid slowing global growth and the US-China trade war. During times of severe economic stress, the Fed can also lend money to deal with financial system distress to prevent credit from drying up, as it did during the 2008 financial crisis, as well as between coronavirus pandemic.

As the virus swept across the nation and rattled businesses and markets across the globe, the Fed bought debt in almost every corner of the market — from Treasuries and mortgage-backed securities that banks used to benchmark mortgage rates, up to – touching corporate debt and local bonds. Of course, the Fed has other mandates, many of which came after the financial crisis. U.S. central banks regulate and supervise the major banks in the United States and maintain the nation’s payment system, through activities such as discount windows or the Fed’s internal check clearinghouse.

The Fed also helps maintain financial stability during difficult times. For example, after the September 11 terrorist attacks, then-Fed Chairman Alan Greenspan quickly announced that the Fed’s discount window was open, hoping to quell the panic.

3. What does the Fed consider when deciding what to do with interest rates?

Fed do not arbitrarily adjust interest rates. US central banks have a dual mandate: maximum employment and stable prices. In the Fed’s ideal economy, everyone who wanted a job would be able to find a job, while inflation was sufficiently contained not to dent consumer purchasing power.

That means officials keep a close eye on employment and inflation metrics, such as the monthly jobs report, the consumer price index (CPI), and the personal consumption expenditures index. (PCE), which is officials’ favorite metric to track price gains.

Fed's impact on inflation
Fed’s impact on inflation

Officials have a specific inflation target of 2%, which they identified in 2012. That is the golden ratio – a ratio that is neither too high nor too low.

But officials are still keeping a close eye on other economic figures that could yield mixed results on employment and inflation. For example, fixed business investment as reported in gross domestic product — the broadest scorecard of the U.S. economy — can indicate whether employers are hesitant or enthusiastic about the future. If a business feels optimistic, they are likely to hire more.

On the other hand, average hourly earnings are often a strong indicator of inflation. If companies have to pay more for workers, they can pass those increases in the form of higher prices to consumers. This process often requires dexterity. If officials raise interest rates too soon, they could risk unnecessarily slowing the economy and leaving more people out of work. However, if the Fed waits too long, inflation could rise. And just as it’s hard to stop a plane taking off on a runway, it’s hard to contain inflation when prices are rising.

The Fed also sets a uniform policy for the entire country, which is often difficult when some areas of the United States are performing better than others. The Fed’s job is ultimately to keep unemployment low for as long as possible without letting the economy overheat for too long, causing inflation. The Fed uses interest rates to steer the economy toward that outcome. But often, Fed officials believe there is a trade-off between the two.

4. How does the Fed affect world finance?

Job of Fed is so complex that the Fed is often misunderstood – or overlooked.

When the Fed lowers interest rates, it reduces yields on consumer products, such as savings accounts and certificates of deposit. Auto loan and credit card rates are also trending lower with the Fed cuts, although they’re still holding higher than lending rates. Mortgage rates are not directly affected by the decisions of the Fed, but they are influenced by the same external market factors that the Fed can. Conversely, interest rates and yields increase when the Fed raises interest rates.

Not to mention, inflation has huge implications for consumers in the United States. If inflation rises, households will lose purchasing power. And if it drops, the money in their wallet is no longer worth it.

With information about What is the Fed?the role & impact of the FED, we hope that investors can take advantage of opportunities based on the information given by the FED to invest effectively.