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Everyday Economics: What is the Fed, and what role does it play in the US economy?

This is the first time since 2018 that the US central bank has raised borrowing costs. The Fed had kept interest rates near zero since March 2020 as the Covid-19 pandemic dealt blows to the US economy

The Federal Reserve building. (Reuters Photo: Joshua Roberts)

The United States Federal Reserve raised its key interest rate by a quarter of a percentage point on Wednesday as the first decisive step to tame runaway inflation that has touched a 40-year high in that country.

This is the first time since 2018 that the US central bank has raised borrowing costs. The Fed had kept interest rates near zero since March 2020 as the Covid-19 pandemic dealt blows to the US economy. With the virus in retreat and prices raging, policymakers have signalled they are pulling support to the economy, and projected another six similar increases of rates over the rest of 2022.

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The US is the world’s biggest economy and the Fed the biggest central bank, and its decisions impact market behaviour around the world. The Fed’s decision to hike rates will also have a bearing on the Reserve Bank of India’s monetary policy review at the next meeting of the Monetary Policy Committee scheduled between April 6 and April 8.

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The US is the world’s biggest economy and the Fed the biggest central bank, and its decisions impact market behaviour around the world. (Reuters Photo)

The role of the Federal Reserve

The US central bank system performs five broad functions to promote the effective operation of the American economy. The Federal Reserve identifies these functions as follows:

Parts of the Fed

While the Federal Reserve has frequent communication with the executive branch and congressional officials, its decisions are made independently. The Federal Reserve System consists of three major entities:

Federal Reserve Chair Jerome Powell. (Reuters Photo: Tom Brenner)

Monetary policy

Monetary policy refers to actions taken by the Fed to influence the availability and cost of money and credit to help promote national economic goals. The Federal Reserve controls the three tools of monetary policy: open market operations, discount rate, and reserve requirements.

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The Board of Governors is responsible for the discount rate and reserve requirements, and the FOMC is responsible for open market operations.

The federal funds rate is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight. Changes in the federal funds rate trigger a chain of events that affect other short-term interest rates, foreign exchange rates, long-term interest rates, the amount of money and credit, and, ultimately, a range of economic variables, including employment, output, and prices of goods and services, the Fed says on its website.

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First published on: 17-03-2022 at 04:42:53 pm
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