How the Fed Steers Interest Rates to Guide the Entire Economy | WSJ — Transcript

Full transcript

1. 0:00- [Narrator] With inflation hovering around
2. 0:01its highest rate in 40 years,
3. 0:03the Federal Reserve is expected to raise interest rates
4. 0:06several times in 2022.
5. 0:09This is Fed chairman Jerome Powell
6. 0:11on what will be needed to ensure a long economic expansion.
7. 0:14- That's gonna require the Fed
8. 0:16to tighten interest rate policy
9. 0:18and do our part in getting inflation back down
10. 0:21to our 2% goal.
11. 0:23- [Narrator] The way the central bank does this
12. 0:24is by changing the federal funds rate,
13. 0:27its main tool for managing the economy.
14. 0:29You can see on this chart that the rate was lowered
15. 0:31to nearly 0% in 2020 to boost the economy
16. 0:35at the beginning of the pandemic.
17. 0:36- There is an important job for us to move away
18. 0:39from these very highly simulative monetary policy settings.
19. 0:44- [Narrator] Adjustments to the federal funds rate
20. 0:45influence a range of borrowing costs,
21. 0:47from how much you own your credit card to mortgage rates.
22. 0:51They also shape broader decisions made by companies,
23. 0:53like how many people to hire or whether to raise prices.
24. 0:57Here's how the federal funds rate works
25. 0:59and how just one rate can guide the entire economy.
26. 1:09- The Fed meets every six or so weeks,
27. 1:11and they're looking at a range of economic data
28. 1:14at those meetings,
29. 1:15but they have two main goals.
30. 1:16One is to ensure stable prices and low inflation.
31. 1:21And the other is to make sure
32. 1:22that the layer market is strong.
33. 1:24- [Narrator] Nick Timiraos covers how the fed guides
34. 1:26the economy through crises.
35. 1:27He says, you can think of the economy
36. 1:29as a car and the fed as the driver.
37. 1:31- They wanna make sure
38. 1:32that the economy's not growing too slow.
39. 1:35And when it is, they'll push on the gas
40. 1:37but they also wanna make sure that it's not going too fast.
41. 1:39And so they'll slow the economy down
42. 1:41by pressing on the break.
43. 1:43- [Narrator] This is where the federal funds rate comes in.
44. 1:45- When you hear on the news
45. 1:46about the fed raising interest rates
46. 1:48or cutting interest rates,
47. 1:50what they're actually deciding to do
48. 1:52is to raise or to lower the federal funds rate.
49. 1:56- [Narrator] This is the interest rate
50. 1:57that banks charge each other to borrow money overnight,
51. 2:00but there's a catch.
52. 2:01The federal funds rate
53. 2:02isn't directly set by the federal reserve.
54. 2:05So in order to influence it,
55. 2:07the fed uses a couple of other tools to set a target range.
56. 2:10These tools are rates that the fed controls in its role
57. 2:13as a bank for banks.
58. 2:15Here's the target range that was in place during 2021.
59. 2:18The federal reserve sets an upper limit and a lower limit
60. 2:21with the goal of keeping the effective federal funds rate
61. 2:24somewhere in between.
62. 2:25The upper limit is determined
63. 2:27by interest on reserve balances.
64. 2:29This is the rate of interest a bank gets on deposits
65. 2:32known as reserves that it keeps at the federal reserve.
66. 2:35The lower limit is determined
67. 2:36by overnight reverse repurchases.
68. 2:38These are securities like treasury bills,
69. 2:41but the federal reserve lends to banks usually for a day
70. 2:44while paying interest.
71. 2:46On this chart, you can see where the fed
72. 2:47has set the target range between the two yellow lines,
73. 2:50the blue line, which is the effective federal funds rate
74. 2:53set by banks sits between the upper and lower limits
75. 2:56as the target range changes
76. 2:58the effective rate goes up or down with it
77. 3:00- So far they've had very successful control
78. 3:03over guiding the federal funds rate
79. 3:05and guiding all short-term money market rates
80. 3:08to where they generally are trying to move them.
81. 3:12- [Narrator] The fed makes these adjustments
82. 3:13in fairly small increments.
83. 3:15Its rate increases for 2022 are expected to only change
84. 3:18by about a quarter to half of a point at a time.
85. 3:22So how can these tiny adjustments for banks
86. 3:24help cool down the entire economy?
87. 3:27It all has to do with how those rates
88. 3:29ripple through the system.
89. 3:30As banks are charged more to borrow,
90. 3:32they'll in turn charge their customers more,
91. 3:34affecting the cost of existing loans
92. 3:36and demand for new borrowing.
93. 3:38The goal of raising these rates is to drive down demand.
94. 3:42- Inflation results when supply and demand are outta whack.
95. 3:45The fed can't do anything to increase the supply of oil
96. 3:49or to increase the number of houses for sale.
97. 3:52The supply side is something out of their reach,
98. 3:55but they can bring supply and demand by reducing demand.
99. 3:59- [Narrator] Here's how rates can influence demand
100. 4:00and inflation.
101. 4:02When rates are low, more people in businesses
102. 4:04are likely to take out loans.
103. 4:06Higher demand for goods and services,
104. 4:08as well as lower rates allows employers
105. 4:10to open more positions to meet demand
106. 4:12and raise wages to appeal to potential employees.
107. 4:15Consumers then turn around
108. 4:17and spend those wages on goods and services,
109. 4:19which in turn can lead to more jobs and higher prices.
110. 4:22The opposite happens when rates are higher.
111. 4:25Fewer people and businesses take out loans,
112. 4:27job growth slows, and spending decreases.
113. 4:31Higher interest rates may also make it more appealing
114. 4:33to save.
115. 4:34Inflation slows as supply and demand balance out.
116. 4:37While interest rates can be effective
117. 4:39in bringing inflation down,
118. 4:41a rate hike could take some time to make an impact.
119. 4:44- Think about your own life
120. 4:45as you go through making different decisions
121. 4:47about whether to buy a house and how big of a house to buy.
122. 4:49It may take a while for this
123. 4:51to ripple through the housing market, for example,
124. 4:53but in 6 or 12 months, we could begin to see, you know,
125. 4:57less demand if interest rates are high enough
126. 4:59to slow interested consumers.
127. 5:03- [Narrator] But while inflation may take time to come down,
128. 5:05consumers and businesses will likely feel the impact
129. 5:08of higher interest rates on loans, mortgages,
130. 5:11and credit cards right away.