The Federal Reserve sets monetary policy for the United States. These policies have a direct and profound impact on the economPreview (opens in a new tab)y, prices, & lending. Typically, the Fed continually reviews current statistics relating to inflation, unemployment and gross domestic product. Based on their findings, there are only so many tools the Fed has in helping guide the economy.
The two tools most commonly used is the setting of interest rates as well as controlling the flow of money by printing currency.
The first is what most people consider the easiest: Setting interest rates to stimulative levels which allows the lending of money to banking and financial institutions. These institutions borrow money from the Fed at a low interest rate and in turn lend to businesses and consumers in the form of bank loans, credit cards, mortgages, car loans, college loans, etc. The interest rate is increased to borrowers thereby providing revenue to the lending parties.
When interest rates are low, money is cheaper to borrow and thereby it is easier to service the debt. When interest rates rise, borrowing lessens and the economy slows as few businesses and people have the ability to service a more expensive loan.
An example of this was seen in our lifetimes, the 1970’s. Interest rates ranged in the high teens, and it was fairly common to have a mortgage at 18%. When you compare that to the current 4.5% rates, it is easy to understand why a home buyer would not be able to afford the same purchase.
Your Monthly Mortgage Debt Service
2013
Mortgage: 4.5%
Loan Amount: $240,000
Monthly Payment: $1,520.06
1977
Mortgage: 18%
Loan Amount: $240,000
Monthly Payment: $4,521.26
In September of 2001, right after the terrorist attacks on the U.S., Former Federal Reserve Chairman Alan Greenspan knew he had to let the world know the U.S. was still open for business and prevent a flight of capital. Now, he faced the potential of the terrorist conceived notion, a very realistic one, that their attacks on NYC and the Pentagon would strike a blow to the U.S. economy. He did one of the only things available to him, steadily reduced interest rates in succession. The interest rates were already in the process of being lowered as of January 2001 to help alleviate the recession of 2000.