The Federal Reserve (the Fed) is constantly monitoring the U.S. economy and conducting transactions in the open market, but what exactly is the Fed trying to accomplish? Why does the Fed change interest rates? Why does the Fed change banking reserve requirements? And perhaps most importantly, how does the Fed help each of us individually?
[VIDEO] The Goals of the Federal Reserve
The Federal Reserve actually has the following six general goals that it is trying to meet—which were established by the U.S. Congress in the Employment Act of 1946 and the Full Employment and Balanced Growth Act of 1978.
- Stability in the financial system
- Price stability—fighting inflation
- Full employment
- Economic growth
- Interest rate stability
- Currency stability
Stability in the Financial System
One of the Fed’s major concerns—especially as of late—is maintaining the stability of the financial system. After all, we have all grown accustomed to a stable, fluid financial system that allows us to save, invest and transfer money without having to worry about anything. A stable financial system allows potential homeowners to get mortgages, students to get loans, businesses to get financing, drivers to lease cars and consumers to use their credit cards. Without a stable financial system, the credit market grind to a halt and the economy stagnates.
Price Stability—Fighting Inflation
Inflation is the thief that robs us all of the purchasing power of our wages and our investments. We’ve all heard the stories about how gasoline used to be 10 cents per gallon, stamps cost a penny and you could buy a home for $15,000. Well, thanks to inflation, those prices are ancient history. When inflation rises, we get less bang for our buck. The Federal Reserve is actively monitoring prices so it can step in and fight inflation whenever it poses a threat.
The Federal Reserve wants to see full employment in the United States. Now, there is some debate as to what constitutes full employment, but it is generally agreed that a five percent unemployment rate, or less, constitutes full employment. The Fed recognizes that there will never be a time when there is no unemployment—due to people changing jobs and so on—but it does tailor its policies to try to accomodate an economic environment that makes it as easy as possible for anyone who is looking for work to find it.
Life in the United States is best when the economy is growing. More people have jobs, American businesses are able to produce and sell more and the average quality of life for U.S. citizens tends to increase. Of course, when the economy is not growing, we see just the opposite. More people are unemployed, American businesses are not able to produce and sell as much and the average quality of life for U.S. citizens tends to decrease. Congress knows its constituants are happier when the economy is growing so it has given the Fed the task to ensure economic conditions are condusive to growth.
Interest Rate Stability
Business owners and consumers are both concerned with interest rate stability. Having an idea of where interest rates are going to be in the future has a dramatic impact on purchases today and planning for future purchases and financing.
The Fed—when focusing on interest rate stability—isn’t necessarily concerned with whether interest rates are low or not. The Fed is more concerned with whether or not interest rates stable. When interest rates are stable, it allows the government, businesses and individuals to effectively plan for the future, which enables the economy to thrive. Conversely, when interest rates are unstable, it becomes incredibly difficult for the government, businesses and individuals to plan for the future with any sort of assurity, which ultimately crimps economic growth.
The U.S. dollar (USD) is the world’s reserve currency and its value has a direct impact on the stability of the U.S. economy. When the U.S. dollar is strong, it enables U.S. consumers to import less expensive goods from other countries. When the U.S. dollar is weak, it allows U.S. manufacturers to export more goods to other economies.
The Fed isn’t necessarily concerned with whether the U.S. dollar is strong or not. The Fed is more concerned with whether or not the value of the U.S. dollar is stable. When the value of the U.S. dollar is stable, it allows the government, businesses and individuals to effectively plan for the future, which enables the economy to thrive. Conversely, when the value of the U.S. dollar is volatile—bouncing back and forth and back and forth—it becomes incredibly difficult for the government, businesses and individuals to plan for the future with any sort of assurity, which ultimately crimps economic growth.