Lately, the financial press talks non-stop about the Fed doing this and that to the interest rate. What exactly is this interest rate that the financial press is talking about?
Why is this Fed interest rate so important given that there are so many kinds of interest rates? Such as my savings deposit interest rate, my mortgage interest rate, my car-loan interest rate ... Why is this Fed interest rate so much more important?
Federal Funds Rate
The interest rate at which a depository institution lends funds maintained at the Federal Reserve to another depository institution overnight. The federal funds rate is generally only applicable to the most creditworthy institutions when they borrow and lend overnight funds to each other. The federal funds rate is one of the most influential interest rates in the U.S. economy, since it affects monetary and financial conditions, which in turn have a bearing on key aspects of the broad economy including employment, growth and inflation.
http://www.investopedia.com/terms/f/federalfundsrate.asp#ixzz3mB5kCtvT
While it is true that if the Federal reserve bank makes a change in their rate there is not an immediate change in the other rates that impact consumers; there is some linkage between the federal rate, and the costs of banks and other lenders regarding borrowing money.
Of course the cost of borrowing money does impact the costs for businesses looking to expand, which does impact their ability to hire more workers and expand capacity. A change in business expansion does impact employment and unemployment...
Then changes in employment can cause a change in raises, which can cause changes in prices which is inflation...
Plus the lenders that lend to business see the flow of new loans change as the employment outlook change.
If the costs of doing business for the bank changes or the flow of loans change, they do adjust the rates they pay depositors and the rates they charge borrowers...
How long it will take to change the cost of an auto loan? No way to tell.
Keep in mind that in complex systems, change can be delayed, and won't move in lock step. For example the price of gas\s doesn't always move the same way a price of a barrel of oil does.
The Fed rate is so important because it sets a cost on lending institutions (banks, credit unions). It is the rate of interest that a bank gets by loaning its cash overnight to the Fed. Presumably, the Fed then loans the cash to other institutions around the world.
The banks loan money to individuals at a higher rate. Savers get a rate between what the Fed gives and what the bank gets. When times are tough the Fed will lower their rate to try to increase the lending that banks do. This is called Qualitive Easing.
The overnight rate is very low right now. That means that the Fed cannot lower rates to try to stimulate the economy. So to enable the Fed to do its voodoo they have to raise rates so that later they can lower them if needed.
