What Role Do Interest Rates Play in the Economy?
Investment by Businesses
Governments borrow money by issuing bonds. The interest rate or yield on these bonds is a measure of the cost of debt for the government. When interest rates are low, it's cheaper for governments to borrow, which can impact fiscal policy decisions.
Interest rates serve as a critical mechanism in the transmission of monetary policy and have wide-ranging effects on various aspects of the economy, from individual decision-making to macroeconomic growth and stability.
How Does the Fed Decide Whether to Raise Interest Rates?
The Fed makes decisions on interest rates based on its dual mandate, which includes:
1. Maximizing Employment: The Fed aims to ensure that as many people who want to work can find jobs.
2. Stabilizing Prices: This means keeping inflation – the rate at which prices rise – at a target level. The Fed has stated that it aims for a 2% inflation rate over the long term, viewing this level as indicative of a healthy economy.
To determine whether to raise, lower, or keep interest rates steady, the Fed examines a plethora of economic indicators and engages in extensive research and analysis. Some of the primary factors and data it considers include:
Labor Market Data
Financial Market Conditions
Global Economic Conditions
Consumer and Business Sentiment
Readings from Financial Models
Input from Regional Federal Reserve Banks
Public and Market Expectations
The Fed also considers how the public and financial markets expect it to act, as well as the potential impacts of its decisions on expectations for future inflation and economic activity.
During the Federal Open Market Committee (FOMC) meetings, members discuss these factors and come to a decision on interest rates. The decision-making process is based on a consensus model, and while individual members might have differing views, the goal is to make decisions that are in the best interest of the broader U.S. economy.
The Federal Reserve’s decisions on whether to raise to lower interest rates can have a significant impact on both the economy and financial markets, but at any given time, there can be a host of other factors at play. If you are interested in consulting with a financial advisor to determine how the economic environment could affect your portfolio, contact Chicago Partners to set up an introductory meeting.
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