Client Communication Briefing

Who “He” is and why you should care

Many of you have had the chance to meet our spring intern, Greg Cipov. I'm pleased to announce that Greg has joined our team full-time. If you have not met him yet, there will ample opportunity in the coming months. Greg's degree is in economics and he put together the following Client Communication Briefing on the impact of the Federal Reserve on interest rates.

Who 'He' is and Why You Should Care

Ben Bernanke is the current Chairman of the Board of Governors of the Federal Reserve Bank and he plays quite a large role in everyone's life. As chairman he makes decisions that will not only affect Washington but also affect you and me. The main mission of the Board of Governors is to keep unexpected inflation to a strict minimum. Inflation is defined as the general rise in prices when compared to previous years, and is mainly due to people spending more than normal (if more people are buying things, producers are going to raise their prices). One indicator Mr. Bernanke pays close attention to is something called the consumer price index (CPI). This is a 'basket' of goods that is constantly being purchased throughout the country. If it costs more to buy that 'basket' than it did the time before you can expect it will be attributed to an increase in inflation.

If it looks like inflation will increase beyond what is expected (expected inflation is approximately 3% per year) the board will do all in its power to stop it. Their most commonly used tool is changing the Federal Funds Rate. The Fed Funds Rate is the rate that banks lend to each other and has a profound impact on spending throughout the country.

It works like this: suppose data shows the 'basket' of goods costs 4% more this year than it did last year, the Board of Governors would want to slow down spending. In order to do this they would want to raise the Fed Funds Rate. This would force banks to raise both the savings interest rates and lending interest rates. This would make us all save more because we would get a higher interest rate and borrow less because it would be more expensive to do so. Through that, spending would slow which will lower inflation. Tah-dah! It also works in reverse, remember after September 11, 2001 mortgage rates went to an all-time low. This is because the Fed Funds Rate was extremely low. This was done to keep our economy strong by enticing people to spend more money.

So, the next time Mr. Bernanke talks about inflation and the Federal Funds Rate you now have a better idea of what he is talking about.