Money In the Media #2

The Feds Just Cut Interest Rates. Here’s What That Means for You

This week on Money in the Media Mondays, I’m reviewing a very necessary article by the NY Times called “The Feds Just Cut Interest Rates. Here’s What That Means for You”. This article deep dives into why the feds cut the interest rate, as well as what that could mean for the every day accounts we all may hold.

If you’re concerned, let me quell those fears right now. It’s not a big deal, but if you would like to learn a bit more about the Federal Reserve, what the interest rate is and what it all means, then read on dear reader!

What is the Federal Reserve?

You may be thinking to yourself, “Why would they cut the rates if the market is the highest it’s ever been?” and that is a fantastic question. First let me make sure that we’re all playing with the same deck of cards and give some background on the Federal Reserve itself.

The Federal Reserve building in Washington. Lexey Swall for The New York Times

The Federal Reserve was set up in 1913 to govern the monetary system in the United States. The Reserve was created as a separate body from the rest of the government to ensure that it remain shielded from political influence. It is not funded through Congress and does not need the approval of Congress (or the President) to enact policies of its own. However, since we work to maintain a system of checks and balances in the US, the Federal Reserve is not omnipotent over all monetary matters. They must uphold the laws and policies passed by Congress.

“The Office” break from the heavy Federal Reserve talk.

The Federal Reserve is split into two main bodies, the Board of Governors and the Federal Reserve Banks. They divide their duties similarly to Michael and Jim on Season 6 of “The Office.” The Board of Governors is “big picture” and oversees the Federal Reserve system as a whole. Meanwhile, the day to day operations of the Federal reserve are maintained by the Federal Reserve Banks, which consists of 12 banks headquartered in varying regions around the US.

What is the Federal Funds Interest Rate?

The federal funds interest rate is the target interest rate at which banks can charge each other for overnight loans on their reserves. When you add money to your bank account, it doesn’t just sit in your account. It gets loaned out to other banks, companies and individuals for various types of loans. Inevitably causing a cascading effect from what the banks can get on their money to what you can earn on your money that is saved through that same bank.

This target interest rate is set by the Federal Open Market Committee (FOMC), which is made up of members from both the Board of Governors and the Federal Reserves banks.

Why Would the Federal Reserve Cut the Federal Funds Interest Rate?

Banks need to meet a minimum balance located at reserves banks or in vault cash. Banks loan each other money to maintain these balances and the rate that they negotiate between each other is called the effective interest rate. When there is more supply than demand, meaning banks have higher balances in the bank, the effective interest rate will go down. This can happen for many reasons, but generally, if the banks are holding cash reserves as opposed to reinvesting in the economy this can effect the total amount of money and credit in the economy at any given time. This will in turn have effects on employment rates and inflation.

Lowering the target interest rate is meant to give incentive for banks to move their money from the reserve banks and invest it back into the economy. This can be done to prevent a recession by forcing money to flow back into the economy, as the article says “forestalling layoffs” and potentially prodding companies to increase worker wages..

What Does That Mean for us Average Joes and Janes?

Changes in the federal funds reserve target interest rate are intended to cause changes in short term interest rates only and not affect long term interest rates. However, they still cause a domino effect to your everyday consumer interest rates. Something I appreciate about this article is that it goes through each of the ways that you could be effected by the federal funds target interest rate. Here’s the TL; DR of what this article says here:

Savings Accounts: These rates are likely to lower by as much as the .25% as the federal fund target interest rate has fallen. For example, my Ally savings account was at 2.25% not too long ago and now hovering around 2.10%. Overall, this is still decent considering that for years following 2008 this rate was close to 1% with many other banks hovering closer to zero.

Mortgages: This is actually the reason the we are now refinancing our home. We purchased last year at a rate of 4.875% (30 yr loan) and are now eligible for a rate of 3.625% (20 yr loan). Long term rates, such as mortgages tend to anticipate the market and federal funds target interest rate well in advance so these rates have already been dropping. An important note:

Historically speaking, mortgage rates do not have much farther to fall. In the past half-century, the average 30-year rate has never dipped below 3.3 percent.

Your Borrowing and Spending: Specifically, credit cards and car loans. Unfortunately, these interest rates have been steadily climbing for years and it’s not likely that a small cut in the federal rate is going to effect that. Expect these rates to remain the same… Sorry!

Your job: This interest rate cut was made specifically to help everyone keep their jobs. So, no need to worry. You will be just fine. Keep saving for a rainy and paying off that debt. Nothing but clear skies ahead for now.

Clear Skies over Mt Monadnock in NH.

Wrap It Up!

Basically, it’s not as big of a deal as it sounds. The Federal Reserve is just hedging its bets so to speak and working to give the economy a little boost to help jobs and wages. As a heads up, the rate may even drop by another .25% later this year. In most ways this will also not effect your daily life. However, if you have a higher mortgage rate. I highly suggest that you crunch the numbers on refinancing to see if it’s right for you!

Hopefully this helped you understand a bit more about the federal reserve interest rates and the Federal Reserve as a whole. If you have any questions or thoughts on this, let me know in the comments below!

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