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  • - [Narrator] With inflation hovering around

  • its highest rate in 40 years,

  • the Federal Reserve is expected to raise interest rates

  • several times in 2022.

  • This is Fed chairman Jerome Powell

  • on what will be needed to ensure a long economic expansion.

  • - That's gonna require the Fed

  • to tighten interest rate policy

  • and do our part in getting inflation back down

  • to our 2% goal.

  • - [Narrator] The way the central bank does this

  • is by changing the federal funds rate,

  • its main tool for managing the economy.

  • You can see on this chart that the rate was lowered

  • to nearly 0% in 2020 to boost the economy

  • at the beginning of the pandemic.

  • - There is an important job for us to move away

  • from these very highly simulative monetary policy settings.

  • - [Narrator] Adjustments to the federal funds rate

  • influence a range of borrowing costs,

  • from how much you own your credit card to mortgage rates.

  • They also shape broader decisions made by companies,

  • like how many people to hire or whether to raise prices.

  • Here's how the federal funds rate works

  • and how just one rate can guide the entire economy.

  • - The Fed meets every six or so weeks,

  • and they're looking at a range of economic data

  • at those meetings,

  • but they have two main goals.

  • One is to ensure stable prices and low inflation.

  • And the other is to make sure

  • that the layer market is strong.

  • - [Narrator] Nick Timiraos covers how the fed guides

  • the economy through crises.

  • He says, you can think of the economy

  • as a car and the fed as the driver.

  • - They wanna make sure

  • that the economy's not growing too slow.

  • And when it is, they'll push on the gas

  • but they also wanna make sure that it's not going too fast.

  • And so they'll slow the economy down

  • by pressing on the break.

  • - [Narrator] This is where the federal funds rate comes in.

  • - When you hear on the news

  • about the fed raising interest rates

  • or cutting interest rates,

  • what they're actually deciding to do

  • is to raise or to lower the federal funds rate.

  • - [Narrator] This is the interest rate

  • that banks charge each other to borrow money overnight,

  • but there's a catch.

  • The federal funds rate

  • isn't directly set by the federal reserve.

  • So in order to influence it,

  • the fed uses a couple of other tools to set a target range.

  • These tools are rates that the fed controls in its role

  • as a bank for banks.

  • Here's the target range that was in place during 2021.

  • The federal reserve sets an upper limit and a lower limit

  • with the goal of keeping the effective federal funds rate

  • somewhere in between.

  • The upper limit is determined

  • by interest on reserve balances.

  • This is the rate of interest a bank gets on deposits

  • known as reserves that it keeps at the federal reserve.

  • The lower limit is determined

  • by overnight reverse repurchases.

  • These are securities like treasury bills,

  • but the federal reserve lends to banks usually for a day

  • while paying interest.

  • On this chart, you can see where the fed

  • has set the target range between the two yellow lines,

  • the blue line, which is the effective federal funds rate

  • set by banks sits between the upper and lower limits

  • as the target range changes

  • the effective rate goes up or down with it

  • - So far they've had very successful control

  • over guiding the federal funds rate

  • and guiding all short-term money market rates

  • to where they generally are trying to move them.

  • - [Narrator] The fed makes these adjustments

  • in fairly small increments.

  • Its rate increases for 2022 are expected to only change

  • by about a quarter to half of a point at a time.

  • So how can these tiny adjustments for banks

  • help cool down the entire economy?

  • It all has to do with how those rates

  • ripple through the system.

  • As banks are charged more to borrow,

  • they'll in turn charge their customers more,

  • affecting the cost of existing loans

  • and demand for new borrowing.

  • The goal of raising these rates is to drive down demand.

  • - Inflation results when supply and demand are outta whack.

  • The fed can't do anything to increase the supply of oil

  • or to increase the number of houses for sale.

  • The supply side is something out of their reach,

  • but they can bring supply and demand by reducing demand.

  • - [Narrator] Here's how rates can influence demand

  • and inflation.

  • When rates are low, more people in businesses

  • are likely to take out loans.

  • Higher demand for goods and services,

  • as well as lower rates allows employers

  • to open more positions to meet demand

  • and raise wages to appeal to potential employees.

  • Consumers then turn around

  • and spend those wages on goods and services,

  • which in turn can lead to more jobs and higher prices.

  • The opposite happens when rates are higher.

  • Fewer people and businesses take out loans,

  • job growth slows, and spending decreases.

  • Higher interest rates may also make it more appealing

  • to save.

  • Inflation slows as supply and demand balance out.

  • While interest rates can be effective

  • in bringing inflation down,

  • a rate hike could take some time to make an impact.

  • - Think about your own life

  • as you go through making different decisions

  • about whether to buy a house and how big of a house to buy.

  • It may take a while for this

  • to ripple through the housing market, for example,

  • but in 6 or 12 months, we could begin to see, you know,

  • less demand if interest rates are high enough

  • to slow interested consumers.

  • - [Narrator] But while inflation may take time to come down,

  • consumers and businesses will likely feel the impact

  • of higher interest rates on loans, mortgages,

  • and credit cards right away.

- [Narrator] With inflation hovering around

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