How the Federal Reserve Affects Your Money

By now, you've probably noticed that your once high-yielding savings or CD account is currently only paying you a paltry return to what it used to. If you don't know why, it's mainly because of the economy and the Federal Reserve. The Federal Reserve, or The Fed, controls the money flow of the U.S. economy. It has many tools at its disposal to do so. One of the most commonly heard ones is its control on interest rates. The Fed Rates The Fed is one of the main components to how bank rates are determined. It dictates the amount of money circulating into the U.S.'s financial system by raising and lowering interest rates, similar to how you turn your water on and off like with the faucet--hence the term liquidity. Their goal is to maintain a balance that prevents inflation--when the dollar value goes down--or deflation--when assets lose value. There are two interest rates that have a direct impact on what banks pay you for your deposit accounts: Federal Funds Rate: This is the rate banks charge each other to borrow funds ove ight. Though banks determine how much they actually charge one another, it usually doesn't stray too far from the federal funds rate. Discount Rate: This interest rate is what the Fed makes banks pay to borrow funds directly from it to meet their reserve requirement. It is usually higher than the federal funds rate because the Federal Reserve wants to use this only as a last-resort for banks that need access to capital. When the economy is slow like it is now, the Fed will generally lower rates to provide more money into the financial system. The idea is that increasing the money flowing into the economy will make it easier for banks to lend to businesses and consumers. This also makes it more practical to spend rather than save because interest rates aren't as attractive. In the same token, it's also better to borrow because interest rates are low. The opposite is true when the economy is booming. The Federal Reserve will actually raise rates to entice consumers to save, and make it harder to borrow.