The Federal Reserve Board: What They Do & Why We Watch

What inflation means for you, your wallet, and your favorite restaurant.

Data released by the U.S. Bureau of Labor Statistics on April 12th showed that prices in the United States (measured by the Consumer Price Index) rose by 8.5% since April of 2021. This represents the largest year-over-year increase since 1981, the year Ronald Regan took the oath of office.

With inflation near record highs, all eyes are on the Federal Reserve Board (“the Fed”), which manages our country’s monetary policy. All of us experience the downstream impacts of the Fed’s decisions, so it’s important to have a clear picture of how they are made.

At a high level, the Federal Reserve Board is responsible for setting interest rates, managing money supply, and regulating financial markets in our country.

During recessionary periods, monetary policy is crafted to reduce interest rates, increase monetary supply, and encourage lending & borrowing. Reduced interest rates make borrowing easier and increased monetary supply ramps up spending across the board. This is done to ensure our country has price stability and maximum employment.

During periods of substantial growth and inflation, interest rates are hiked, monetary supply is reduced, and, as a result, lending & borrowing are discouraged. Increased interest rates make borrowing more expensive and reduced monetary supply tamps down spending across the board.

In a perfect world, interest rates, monetary supply, and lending & borrowing would all be just right all the time. Unfortunately, that is never the case; in fact, many investors and economists think the Fed is far too reactive as of late.

Take a look at the immediate impact of interest rate hikes; on November 10th, 2021, the 30-Year Fixed-Rate Mortgage Average was 2.98%. On April 21st, 2022 – less than six months later – the average was 5.11%.

Let’s illustrate this with an example: a consumer wants to move into a home that’s closer to their children’s school. They currently live in a $500,000 home and will be moving to a new $500,000 home. Assuming 20% was put down and 80% was financed in both cases, they will be swapping their current monthly mortgage payment of $1,682 for a new payment of $2,174. That’s another $492 per month (29% higher), $5,904 per year and $177,120 over the life of the loan…for homes that are worth the same amount.

While there is still great demand for homes because of the limited supply, you can see how broadly interest rates impact the economy, which is why we watch the Fed so closely.

For consumers, today’s high inflation rate means paying more and earning less. Annual raises for employees are typically 2-3% per year. When inflation exceeds that rate, employees experience a pay cut. As prices for groceries, gas, and luxury goods rise, consumers first look to reduce their discretionary spending, cutting back on leisure and travel just to break even. That immediately impacts the hospitality, leisure, and tourism industries.

Take your favorite local restaurant. When consumers cut back, it means fewer meals out and more eating in. With fewer customers patronizing the business, revenue declines. Meanwhile, the restaurant’s labor, gas, electric, borrowing, and food costs have risen…not a good mix! With wages up, it’s harder to find and retain workers. The pressure is on to offer salaries that compete with large national chains, which leaves local restaurants and the staff that remain, overworked.

In conclusion, the Fed is responsible for making decisions that impact all of our lives very directly. They can hike or reduce interest rates, buy or sell securities in the open market, and increase or reduce reserve requirements for borrowing and lending.

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