Question

The Federal Reserve uses different tools to promote maximum employment and stable prices.

• How do monetary policy actions made by the Federal Reserve affect interest rates?
• Feel free to include some examples from recent interest rate hikes.

Answer 1

The Federal Reserve implements monetary policy for the country by controlling the level of short-term interest rates and by manipulating the economy's availability and cost of credit. Monetary policy has a direct impact on interest rates; it has an indirect impact on stock prices, income and currency exchange rates. Monetary policy affects in the United States spending, investment, growth, wages, and inflation through these channels.

Short-term interest rate fluctuations also affect long-term interest rates such as corporate bond rates and residential mortgage rates because those rates represent the actual and expected future short-term rate prices, among other factors. Furthermore, long-term interest rate movements have an effect on other asset prices, most importantly stock prices and the dollar's foreign exchange value. For example, everything else being equal, lower interest rates tend to raise equity prices as investors are at a lower rate discounting future cash flows associated with equity investments.

These changes in financial conditions in turn have an effect on economic activity. Of example, as short-and long-term interest rates go down, borrowing is cheaper, and consumers are more likely to buy goods and services, and companies are more able to buy products of increasing their businesses, such as property and equipment. Companies respond to these rises in overall spending (household and business) by hiring more workers and boosting production. As a consequence of these factors, household wealth rises, spurring far greater spending

Monetary policy also has considerable influence on inflation. When the federal funds rate is decreased, the resulting increased demand for goods and services tends to push higher wages and other costs, representing the higher demand for workers and resources required to produce. Furthermore, policy decisions will affect perceptions about how the economy will perform in the future, including expectations of prices and wages, and those expectations can directly influence current inflation itself.