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Why Does the Federal Reserve Raise Interest Rates? And What’s Wrong with the Fed Anyway?



Why does the Federal Reserve need to raise interest rates for what is clearly a temporary spike in the price of a barrel of oil – from a cyber-attack that is obviously orchestrated?

I understand that when money is flowing and spending is high, the Fed needs to raise rates to cool off the frothiness of the economy. But this is not the case right now, and this move should raise the price of a barrel of oil even higher, sending the economy into a tailspin.

Why is the Fed willing to sabotage its own economy over a temporary issue? Does the Fed really mindlessly react to numerical values without any thought given to the causes?

—Adam in Massachusetts 

Howard Dvorkin CPA responds…

I’m happy to answer these questions – even though the Colonial Pipeline hacking ended last week, and even though the Fed hasn’t raised interest rates at all.

In fact, that’s why I want to answer these questions. Too many Americans misunderstand what the Federal Reserve does, and they get mad at decisions “the Fed” hasn’t actually made.

So, let’s use Adam’s questions as a short lesson in Fed-onomics.

Did the Fed just raise interest rates?

No, the Federal Reserve—which is run by seven members appointed by the President and confirmed by Congress—did not raise interest rates during the Colonial Pipeline cyber-attack. In fact, the Fed hasn’t raised interest rates in years. The last time was in 2018.

Just to be clear: The Fed doesn’t directly raise your interest rate. It doesn’t control your credit card, mortgage, or auto loan. Instead, it decides on something called the “benchmark interest rate” or “federal funds rate,” which is basically the interest rates banks pay.

So of course, any hike by the Fed will eventually trickle down to us. Still, it’s a crucial distinction because the Fed doesn’t deal with consumers. It’s a complex organization that works with financial institutions—which have a compelling interest not to “sabotage” the economy. This leads to Adam’s next question.

Is the Fed “willing to sabotage its own economy”?

No, the Fed doesn’t want to hurt the economy. In fact, it was created in 1913 to stabilize the economy. The Fed is the central bank of the United States, but even though it was founded by Congress and its members are political appointees, the Fed is totally independent of politics. Neither Congress nor the President can boss them around.

One big reason for that: A term on the Fed’s Board of Governors is 14 years.

The Fed’s mission has become a delicate balancing act: Slowing the economy when it overheats so inflation doesn’t run rampant, while not slowing it so much we fall into a recession.

Needless to say, The Fed is run by human beings, and they don’t always get it right. In fact, the Fed’s critics say those members seldom get it right. However, I’ve never heard any of those critics accuse the Fed of intentionally sabotaging the economy. After all, the Board of Governors consists of Americans who rely on that very same economy. They’re also generously compensated: More than $200,000 for the chair and more than $180,000 for the others. If they sabotage the economy, they’re also sabotaging their own incomes.

Does the Fed “mindlessly react”?

Even its harshest critics wouldn’t call the Fed a knee-jerk institution. Some of those critics urge the Fed to do more and do it faster. They want the Fed to address issues like income equality and climate change, but the Board of Governors has a history and a reputation for moving slowly on even its core mission, much less assuming new ones.

I have my own opinions about the Fed’s strengths and weaknesses of the Fed, and you’re not likely to find many fans or apologists who agree with every decision it has made. Still, it’s important to know exactly what the Fed does before you know exactly what you like or don’t like about it.

So, this might not be what Adam wants to hear, but it sounds like he and the Fed actually agree more than they disagree.

TrustScore 4.6


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