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INVESTMENT FUNDAMENTALS What is the Federal Reserve? ©2024 SEI® 1 The Federal Reserve (Fed) is the central bank of the Unites States. Like all central banks, it employs a variety of tools in an effort to encourage or discourage economic activity and maintain a stable economy. Specifically, the Fed seeks to maintain maximum employment and price stability. These actions are referred to as monetary policy. How does the Fed achieve its goals? The Fed seeks to achieve maximum employment and price stability in the U.S. economy through control of the U.S. money supply by increasing or decreasing interest rates. When there are signs that the economy is overheating (i.e. growing too quickly) the Fed raises the federal-funds rate (the rate of interest commercial banks charge each other for overnight loans). Higher interest rates make it more expensive for borrowers to repay loans, so fewer loans are made. When businesses and consumers borrow less, they spend less, causing the economy to slow. The reverse is also true. When the Fed wants to spur growth in a slowing economy, it reduces interest rates to encourage an increase in borrowing. These interest-rate changes are some of the most visible Fed actions seen by consumers and investors. As shown in Exhibit 1, the Fed kept interest rates low for years to spur the economy in the wake of the global financial crisis, and aggressively raised rates to tame the post-pandemic inflation of the 2020s. Exhibit 1: Federal-funds target rate from the global financial crisis to the inflation of the 2020s Source: Federal Reserve Economic Data (FRED). Federal Funds Target Rate from 1/1/2007-12/15/2008. Average of Federal Funds Target Range Upper and Lower Limit from 12/16/2008-2/27/2024. 0% 1% 2% 3% 4% 5% 6% Percent