Do you use credit? If you do not, you are the exception to the rule. These days, most Americans use credit regularly. Statistically speaking, more than 80% of American households owe some kind of debt. This debt comes in various forms, ranging from high-interest debts like credit cards and payday loans to lower interest debt such as auto loans, mortgages and student loans.
When you add it all up, the total debt owed by American households is a staggering $12.35 Trillion.
Different types of Are subject to different interest rates. As of this writing, the current interest rate for mortgages is around 4.25%. At that rate, the annual cost of interest on our debts is around $525 Billion per year. When you factor in the significantly higher interest rates for credit cards and other personal debt, this number can grow still larger. Every 1% increase in interest results in another $100 Billion in interest payments. Any way you add it up, the cost of debt is an enormous drain on the American economy.
Interest Rates and You
Perhaps you do not use credit; even so, interest rates affect the cost of every item you purchase. Even if you do not use credit, the businesses you purchase goods from, the suppliers and vendors they purchase goods from, the financial institutions they work with and the Federal, State and Local governments all use credit to operate. All of these entities pass the cost of borrowing and lending money on to consumers. There is no escaping the impact of interest rates on your cost of living.
Changing interest rates also influence your financial position in another way; Interest rates also exert a significant impact on the value of your assets. All of your assets and investments, including seemingly immune items like cash and precious metals are subject to pricing variability which is heavily influenced by interest rates.
Interest rates have a significant impact on your life, no matter who you are and what your job is. With this fact in mind, you may wonder where interest rates come from.
Who Sets Interest Rates
No single organization sets the interest rates for America, but the Federal Government has a powerful influence. In the late 19th century, the United States experienced repeated financial panics. These panic led to severe economic disruptions, bank failures and bankruptcies.
In 1907, there was a particularly acute economic crisis. This crisis was precipitated when the United Copper Company attempted to corner the US market in copper. This move led to the failure of the Knickerbocker Trust Company of New York and eventually a 50% loss to the New York Stock Exchange. The crisis was only ended through the intervention of a group of bankers led by J.P. Morgan; these bankers provided $23 million out of their own pockets to stabilize the market and keep the exchange operating.
In response to the economic panic that seized much of the country, Congress instituted the body that came to be known as The “Federal Reserve Bank” in 1913.
The United States Federal Reserve Bank, also known as “the Fed” is arguably the most powerful financial institution in the world. Its function is to monitor and control United States economic policies.[v]
The Federal Reserve bank has four primary functions:
- The Fed implements US economic policy by influencing the cost of borrowing money. The goal is to ensure higher employment rates, stabilize prices for consumer goods and industrial raw materials and moderate long-term changes in interest rates.
- The Fed supervises and regulates United States banking institutions to protect consumers.
- The body maintains the stability of the United States financial system and take steps to reduce risk whenever possible.
- The Federal Reserve provides financial services to the US government and many foreign central banks.
The Federal Reserve system is divided into 12 regional divisions based in Atlanta, Boston, Chicago, Cleveland, Dallas, Kansas City, Minneapolis, New York, Philadelphia, Richmond, San Francisco and St. Louis. The main policymaking body of this institution is the Federal Open Market Committee. A Board of Governors, the president of the New York branch and the presidents of four other branches who serve on a rotating basis govern this committee.
The Federal Reserve Bank owns a large number of US government securities and carefully selected other investments. The income from these investments gives this organization the money it requires to operate. Any excess profits are channeled back to the United States treasury.
The Federal Reserve Bank does not control consumer interest rates directly, but it sets the rate of interest it charges when it lends money to banks and other financial institutions. By manipulating this interest rate, the Federal Reserve Bank influences the cost of borrowing money for every individual, business and local government in America.
Depending on changing economic conditions, the Federal Reserve Bank may take a more or less active role in the economy. Over the years, the Federal Reserve rate has ranged from a low of 0% to a high of 20% during the late 1970s and early 80s when inflation was out of control. The Federal Reserve rate has been stable in recent years. From 2008 to 2015, the Federal Reserve rate was set at 0% to stimulate economic growth. This has undoubtedly been a significant factor in the ongoing economic recovery of the United States since the recession of 2008. Since December 2015, the Federal Reserve has increased its rate twice; the rate is currently set at an extremely low 0.75%, making the cost of borrowing money quite low.
In a typical election year, investors tend to be cautious, until the new administration makes its influence felt. During the most recent campaign, Donald Trump, the eventual winner promised sweeping changes designed to improve productivity. The economic policy of the United States may be poised to change.
Though the government ostensibly does not control the Federal Reserve Bank, the directors of this body are appointed by the President and confirmed by the US Senate. The will of the Federal Government is a significant factor in the decision making process.
As a nation, the United States depends on credit. The majority of American households, as well as most businesses, financial institutions and even governments use credit regularly. The interest rates in our country have a significant effect on the cost of living and working in the United States and the value of our investments.
The United States government does not control interest rates directly, but it does have a strong influence through the Federal Reserve System. The Board of Directors of this financial institution is charged with monitoring and stabilizing the United States economy. It attempts to complete this mission by controlling the interest rate that banks use when they lend money to each other. This influences the interest rates that banks and other financial institutions charge businesses and consumers as well as the return on many kinds of investments.
Due to the recent election, the state of the American economy may be poised to change. Any changes in the interest rate will affect your financial position as well.