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Every month or so, the Federal Reserve Board's meeting makes business headlines. The market is
usually quiet as investors wait for news about the direction of interest rates. A raise in rates
sends stocks tumbling, and a drop in interest rates, especially a bigger than anticipated drop,
will spark a huge rally. So what is this Federal Reserve thing all about?
The Federal Reserve Board's chairman is appointed by the President and confirmed by the Senate, and
many board members are principals of New York investment banks. The Fed oversees the Federal
Reserve Banking System which is made up of 12 regional banks that distribute paper money and act as
a check clearing house for your local bank. Its most visible function is its influence on the
economy by setting monetary policy, manipulating the money supply, by raising or lowering key
interest rates. The Fed funds rate is the one watched by investors and the news media. This is the
rate banks charge one another for overnight loans to cover their minimum cash-reserve requirements.
The discount rate, generally 1/2% less than the funds rate, is the interest rate that banks pay the
Federal Reserve for short-term loans.
Lower interest rates put more cheap money into the banking system, increasing the amount available
to lend to consumers and businesses. Lower interest rates also encourage consumers to spend, and
businesses to borrow for expansion creating more jobs. This boost to the economy is usually felt
about six months after a change in interest rates.
The Fed raises interest rates to cool a "too hot" economy and keep inflation in check.
They drop rates to stimulate the economy. In 2001, the Fed dropped rates a record 11 times to
1.75%, down from 6.5%. Learn more, including the Fed's history at www.federalreserve.org
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