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How the Fed Steers Interest Rates to Guide the Entire Economy | WSJ - YouTube
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- [Narrator] With
inflation hovering around
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its highest rate in 40 years,
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the Federal Reserve is expected
to raise interest rates
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several times in 2022.
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This is Fed chairman Jerome Powell
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on what will be needed to ensure
a long economic expansion.
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- That's gonna require the Fed
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to tighten interest rate policy
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and do our part in getting
inflation back down
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to our 2% goal.
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- [Narrator] The way the
central bank does this
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is by changing the federal funds rate,
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its main tool for managing the economy.
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You can see on this chart
that the rate was lowered
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to nearly 0% in 2020 to boost the economy
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at the beginning of the pandemic.
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- There is an important
job for us to move away
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from these very highly simulative
monetary policy settings.
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- [Narrator] Adjustments
to the federal funds rate
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influence a range of borrowing costs,
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from how much you own your
credit card to mortgage rates.
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They also shape broader
decisions made by companies,
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like how many people to hire
or whether to raise prices.
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Here's how the federal funds rate works
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and how just one rate can
guide the entire economy.
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- The Fed meets every six or so weeks,
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and they're looking at
a range of economic data
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at those meetings,
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but they have two main goals.
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One is to ensure stable
prices and low inflation.
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And the other is to make sure
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that the layer market is strong.
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- [Narrator] Nick Timiraos
covers how the fed guides
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the economy through crises.
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He says, you can think of the economy
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as a car and the fed as the driver.
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- They wanna make sure
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that the economy's not growing too slow.
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And when it is, they'll push on the gas
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but they also wanna make sure
that it's not going too fast.
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And so they'll slow the economy down
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by pressing on the break.
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- [Narrator] This is where the
federal funds rate comes in.
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- When you hear on the news
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about the fed raising interest rates
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or cutting interest rates,
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what they're actually deciding to do
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is to raise or to lower
the federal funds rate.
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- [Narrator] This is the interest rate
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that banks charge each other
to borrow money overnight,
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but there's a catch.
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The federal funds rate
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isn't directly set by the federal reserve.
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So in order to influence it,
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the fed uses a couple of other
tools to set a target range.
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These tools are rates that
the fed controls in its role
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as a bank for banks.
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Here's the target range that
was in place during 2021.
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The federal reserve sets an
upper limit and a lower limit
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with the goal of keeping the
effective federal funds rate
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somewhere in between.
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The upper limit is determined
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by interest on reserve balances.
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This is the rate of interest
a bank gets on deposits
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known as reserves that it
keeps at the federal reserve.
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The lower limit is determined
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by overnight reverse repurchases.
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These are securities like treasury bills,
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but the federal reserve lends
to banks usually for a day
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while paying interest.
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On this chart, you can see where the fed
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has set the target range
between the two yellow lines,
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the blue line, which is the
effective federal funds rate
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set by banks sits between
the upper and lower limits
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as the target range changes
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the effective rate goes up or down with it
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- So far they've had
very successful control
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over guiding the federal funds rate
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and guiding all short-term
money market rates
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to where they generally
are trying to move them.
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- [Narrator] The fed
makes these adjustments
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in fairly small increments.
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Its rate increases for 2022
are expected to only change
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by about a quarter to
half of a point at a time.
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So how can these tiny
adjustments for banks
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help cool down the entire economy?
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It all has to do with how those rates
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ripple through the system.
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As banks are charged more to borrow,
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they'll in turn charge
their customers more,
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affecting the cost of existing loans
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and demand for new borrowing.
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The goal of raising these
rates is to drive down demand.
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- Inflation results when supply
and demand are outta whack.
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The fed can't do anything to
increase the supply of oil
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or to increase the number
of houses for sale.
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The supply side is something
out of their reach,
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but they can bring supply and
demand by reducing demand.
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- [Narrator] Here's how
rates can influence demand
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and inflation.
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When rates are low, more
people in businesses
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are likely to take out loans.
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Higher demand for goods and services,
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as well as lower rates allows employers
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to open more positions to meet demand
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and raise wages to appeal
to potential employees.
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Consumers then turn around
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and spend those wages
on goods and services,
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which in turn can lead to
more jobs and higher prices.
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The opposite happens
when rates are higher.
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Fewer people and
businesses take out loans,
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job growth slows, and spending decreases.
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Higher interest rates may
also make it more appealing
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to save.
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Inflation slows as supply
and demand balance out.
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While interest rates can be effective
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in bringing inflation down,
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a rate hike could take some
time to make an impact.
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- Think about your own life
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as you go through making
different decisions
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about whether to buy a house
and how big of a house to buy.
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It may take a while for this
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to ripple through the
housing market, for example,
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but in 6 or 12 months, we
could begin to see, you know,
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less demand if interest
rates are high enough
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to slow interested consumers.
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- [Narrator] But while inflation
may take time to come down,
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consumers and businesses
will likely feel the impact
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of higher interest rates
on loans, mortgages,
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and credit cards right away.
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