Controlling The Speed Of Money by Kalinda Rose Stevenson, PhD

Of all the ways the Federal Reserve controls the money supply, the one that gets the most publicity concerns interest rate changes.

Before scheduled Federal Reserve meetings, you'll hear a lot of speculation about what the Fed will do. These speculations affect the stock market. Media reports also speculate about the effect of possible interest rate changes on consumer credit cards, mortgages, and auto loans.

This media attention obscures an important fact. The interest rate, which is also called the discount rate, concerns the rate commercial banks must pay when they borrow money from Federal banks. The interest rate changes do not directly affect your credit card interest rate.

Whenever the Fed changes the discount rate, it does so to either make it more or less profitable for the commercial banks to borrow money from the Fed to make loans.

These are the essential points to keep in mind: 1. The purpose of the Federal Reserve system is to control the amount of money in the system. 2. The purpose of commercial banks is to make money. They make money by loaning money to borrowers.

It is a matter of profit. If the banks must pay more to borrow money whenever the Fed raises the interest rate, the banks make less profit from their loans to customers. If the banks can pay less to borrow money whenever the Fed decreases the interest rate, the banks increase their profit from loans to customers.

When the Fed changes the interest rate it charges banks, this affects the speed of money in the economic system. The lower the interest rate, the faster banks can loan out money and increase the amount of money in the system. The higher the interest rate, the slower banks can loan out money. So, even though the interest rate directly affects banks, these rate changes matter to all of us.

The bottom line fact is that the Fed does not change consumer interest rates. The banks might decide to change interest rates on credit cards and adjustable rate mortgages, but these changes are not directly tied to any changes the Fed makes in the rate it charges banks to borrow money.

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