On Tuesday, the Federal Open Market Committee (a part of the Federal Reserve) will hold one of its eight annual meetings to discuss economic policy decisions.  The Federal Reserve, also called “The Fed,” has several important duties.  The most important is that of making sure the economy is growing steadily.  They don’t want the economy to grow too fast, because that usually leads to inflation (prices increasing rapidly).  But if the economy grows too slowly, there is a risk of a recession where the economy actually contracts.  How do they affect the growth rate of the economy?

The most important decision the Fed controls is the federal funds target rate.  Banks borrow money from each other all the time using overnight loans.  The rate of interest they charge each other for these loans is called the “federal funds rate” and is related to the target rate I mentioned above.  Notice that I said “related” to the target rate.  Basically, the Fed announces that it has set a target rate of 0.5%, for example.  The next thing the Fed does is to buy or sell government securities like bonds, which are a loan that someone makes to the government.  By buying or selling lots of these securities, they are either putting in or taking out cash from banks around the country.  If banks have plenty of cash, they won’t need to take out overnight loans, which means that the demand for those loans goes down, and that means the interest rate banks can charge for overnight loans goes down.  That’s how the Fed can attempt to get the real federal funds rate as close to their target as possible.

Right now, the federal funds target rate is 0-0.25%.  The effective federal funds rate today was 0.19%.  Nice job, Fed.

On Tuesday, the Fed will announce what they want the target rate to be.  Pretty much everyone expects them to keep it at 0-0.25%, which is basically as low as they can go.  Investors are also looking to see what the Fed will actually say in their statement.  The Fed’s statement is one of the most closely analyzed statements you’ll find, other than those issued by professional athletes who have cheated on their spouses!  “Oh, they changed it from ‘a long time’ to the ‘foreseeable future’ – oh my goodness!” continue reading…