October 27, 2022
Monetary Policy 101: All Time Low Rates and What That Means For Us
If you’re already an expert on monetary policy, you might see this as beneath your pay grade and should perhaps scroll on. As for everyone else though…
You read all these headlines about the Fed and their rate cuts, easy money, buying bonds, and all these other blanket terms that don’t tell the average listener much at all and assumes an implicit understanding of what’s being discussed. But, what’s actually going on? And, what does that mean for us?
How the Fed Pulls the Strings of the Economy Through Monetary Policy
- The federal reserve is responsible for setting the federal funds rate, which is usually what’s being referenced when the media says the fed is lowering rates.
- The funds rate is the target interest rate set by the FOMC for banks that borrow from each other’s reserves overnight.
- The FOMC is a collection of 12 members. 7 from the Fed, 1 from New York, and 4 rotating, who meet 8 times per year to set rates. Although, they’ve obviously had some extra meetings over the last year.
- The Fed’s goals in adjusting this rate is the epitome of monetary policy. Raising rates is contractionary, lowering them is expansionary and promotes growth/spending.
- Last year when the pandemic hit, the fed chopped the rate range down from 1-1.25% all the way to 0.00-0.25%. This was because of the economic lapse and them feeling the need to make a swift change.
How Rates Impact Everything Around Us
The Fed doesn’t enact big adjustments in monetary policy for no reason, assuming the only ones to be impacted would be the banks themselves. No, the borrowing banks in question end up passing these adjustments onto us, the citizens of the country, by way of interest rates on almost everything else.
The Fed dropped the rates with the intent of lowering the effective interest rates on other financial products too. Interest rates on loans, mortgages, lines of credit, even savings accounts are all essentially at or near all-time lows.
Rates are expected to remain in this range through the end of 2023, while the Fed targets a 2% long-term average inflation rate and maximum employment, and we ultimately may not see interest rates collectively take off until 2025 – 4 years away! –.
- Mortgages: Mortgage interest rates have been dropping for decades, but we’re at unprecedented levels of low right now. This has contributed to the housing market almost catching on fire at this point, and has helped to drive up home prices over the last 12 months. Good or bad? Depends on which end of the sale you’re on.
- Savings: As you might have noticed by way of an increased number of emails from your “high-interest savings” bank over the last 12 months, when the funds rate drops, savings rates tend to do the same.
- Employment: Easier money, in theory, should equal more spending, business expansion, optimism, and, in a roundabout butterfly effect type of way, eventually more hiring. This should help to continue opening up the job market. That is, if we ever resolve our war on wages.
- Other risks: This all sounds mostly good, but it’s also risky to an extent. Dropping rates this low is kind of like pulling out all the stops since they can’t be reduced much more, and could result in the Fed engaging in alternative measures of driving expansion, like partaking in more quantitative easing than they already are when monetary policy is rendered ineffective. Or, the risk of falling into a liquidity trap in which people would rather save than spend or hold securities that will essentially return a net negative yield.