Monday, June 25, 2007

The Federal Reserve and how interest rates are set.

You have probably heard about the Federal Reserve once or twice through your favorite news outlets. You may have also known that special members of the Federal Reserve hold meetings frequently to discuss interest rates and whether or not to raise or lower them. More information on monetary policy meetings here.

The Federal Reserve has a very profound effect on interest rates through changing what is known as the "discount rate. This is the rate in which money is disbursed to member banks in the form of loans. Member banks are required to keep reserves and sometimes need to borrow money to meet reserve requirements. These member banks also make loans to other banks, who in turn use that money to lend to corporations and individuals such as students. Major financial publications such as the Wall Street Journal, post the discount rate and other economic data in or around the front pages for investors to see. This data serves as a cluster of indications of the state of the economy and consistently reading these publications can give you tips on how to approach any investments and loans you may have. The one thing to take from all of this is: the higher the discount rate, the higher the cost of lending to you the borrower.

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