The Fed Just Raised Rates (Again!) Here's What That Means in Plain English

We haven't seen rate hikes like this since 1994.

Inflation has been on everyone's mind recently. Google Trends reports that search queries for the topic are at an all-time high since data collection began in 2004. But consumers aren't the only ones taking notice. Read on to learn more about how the Federal Reserve is taking action on inflation.

What is the Fed?

The Federal Reserve, or Fed, is the central bank of the United States. Since 1913, the bank has stood as the watchdog for financial crises. Controlling the largest economy in the world is no small feat, so the Fed is guided by a dual mandate and sets monetary policy to achieve them.

The Fed has two jobs: to maintain maximum sustainable employment and to keep prices stable. Maximum sustainable employment relates to unemployment rates, which the Fed aims to keep around 4.1%. As of this writing, 3.6% of Americans are unemployed, well within the target range of the Fed. The other mandate of the Fed is the "I" word: Inflation. With a target inflation rate of 2%, the current rate of 9.1% is well out of range. What is the Fed to do?

As it turns out, the financial crisis watchdog has some bite. The Federal Open Market Committee, or FOMC, is a division of the Fed that manages the economy. By reducing the money supply, the FOMC can "cool off" the economy, and vice versa. One tool available to the FOMC is called Open Market Operations, where money in circulation can be increased or decreased by buying or selling treasury securities. Another tool is the reserve requirement, which determines how much money banks must maintain in un-lent holdings. Finally, there are discount rates, or interest rates, which we will talk more in-depth about below.

What are interest rates and why are they being raised?

As mentioned above, the job of the Fed is to maintain low unemployment and inflation rates. Currently, the focus is on reining in runaway inflation. One way to do that is by reducing the amount of dollars in circulation. The idea is that fewer dollars in the economy lead to less consumer spending, which slows inflation.

The third tool in the FOMC's toolbox are discount rates. Discount rates are the interest rates charged to banks which borrow money from the Federal Reserve. When the Fed wants to cool off the economy, they raise these interest rates, making it more expensive for dollars to enter the economy.

Does this rate hike really make a difference? Consider that in June of 2022 alone, over $21 billion were borrowed from the Federal Reserve. Even a moderate increase in the interest rates on these borrowings could lead to billions of dollars fewer of future borrowings. Also consider that these rate hikes are some of the largest in recent history. With a recent rate hike of the same size in June, the Fed is believed to be moving at its fastest pace since 1981.

What does this mean for the average consumer?

For consumers and business owners seeking to borrow money, the Fed's latest move might make you reconsider those plans. Although individuals do not borrow money directly from the Federal Reserve, their banks do. These banks in turn charge higher rates to their customers. The intention of raising inflation rates is to slow down spending at all levels, including making it harder for families and business owners to borrow money.

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Those seeking most kinds of borrowing will be affected by rising rates the most over the coming months and years. Auto loans, mortgage loans, consumer debt, and business loans are all likely to become more expensive in the near future. The only way to fight inflation is to slow down the money supply, but for families being hammered by rising costs, the high cost of borrowing will sting.