Why Does the US Federal Reserve Raise and Lower Interest Rates?

What is the US Federal Reserve?

The Federal Reserve, often referred to as the Fed, is the US central bank and monetary authority. It was established by the Federal Reserve Act in 1913, which gave the Fed responsibility for setting monetary policy in response to the 1907 Banker’s Panic.

“The Panic was caused by a build-up of excessive speculative investment driven by loose monetary policy,” explains Investopedia. “Without a government central bank to fall back on, U.S. financial markets were bailed out from the crisis by personal funds, guarantees, and top financiers and investors, including J.P. Morgan and John D. Rockefeller.”

Although it is an independent government agency, the Fed is accountable to the public and US Congress. The current Fed Chair is Jerome Powell, an investment banker who served as assistant secretary and undersecretary of the Department of the Treasury under former President George H.W. Bush. Powell took the helm at the Fed in 2018.

The Fed has a dual mandate: to achieve stable prices and stable employment. The government agency also provides banking services and is the main regulator of the nation’s banks. In times of economic turmoil, the Fed also acts as a lender of last resort.

It’s important to note that while the Fed manages the national monetary policy and regulates the financial system in the US, its actions also have a powerful influence on the global economy.

What is the FOMC?

The Federal Open Market Committee (FOMC) is the Fed’s monetary policy-making body. The 12 members of the FOMC are the seven members of the board of governors of the Federal Reserve System, the president of the Federal Reserve Bank of New York and four of the 11 reserve bank presidents who rotate through the positions for one year terms.

Why does the US Federal Reserve hike or cut interest rates?

For more than a century, the Fed has been tasked with keeping a watchful eye on any structural risk to monetary stability in the US financial system, and rising inflation and high unemployment are two of the biggest threats to monetary stability.

In the face of rising inflation, the Fed raises interest rates in the hopes of reigning in rapidly rising prices by curbing demand. When interest rates are higher, borrowing money becomes more expensive, which ultimately slows consumer spending and curtails corporate growth.

During times of slow economic growth, the Fed lowers interest rates in order to stimulate the economy. Lower interest rates in effect lower the cost of borrowing and investing for both businesses and individuals.

The Fed’s goal is to keep inflation around its target rate of 2 percent, and unemployment around 4 to 4.5 percent.

“The principle of inflation targeting is based on the belief that long-term economic growth is best achieved by maintaining price stability, and price stability is achieved by controlling inflation,” according to Investopedia.

What are the biggest contributors to US inflation?

Inflation is calculated through factoring in price changes of a weighted basket of goods and services, as well as housing.

For example, the COVID-19 pandemic that began in 2020 caused a surge of inflation in the US and globally.

Prices of goods were driven higher by a mix of factors, including significant supply chain disruptions hurting product availability, and economic stimulus packages increasing spending power and demand.

Additionally, the lasting switch to work-from-home for many led to increased demand for homes with space for offices, driving up housing prices. As housing is the highest weighted factor when calculating US inflation, this was one of the biggest drivers of inflation in the 2020s.

Global supply chains have since been hampered by factors like Russia’s ongoing war in Ukraine and growing conflict in the Middle East. There is also the uncertainty generated from the global wave of tariffs sparked by US President Donald Trump’s trade policies, which will raise the cost of goods purchased by American consumers.

This global supply and demand imbalance has led to rising prices for a wide range of consumer products, from gas to groceries. The result has been a loss in purchasing power for US consumers as their dollar needs to stretch further.

How much has the US Federal Reserve hiked rates since 2022?

In an effort to fight inflation, the American central bank consistently increasing rates from its March 2022 meeting with an initial boost of 25 basis points. Its hike of 75 basis points in June 2022 was at the time its largest since 1994, and it was followed by another three hikes of this magnitude in 2022.

The Fed raised interest rates by 5.25 percentage points between March 2022 and July 2023 before holding at 5.50 percentage points for more than a year. The Fed’s current rate cutting cycle began with a .50 drop in September 2024.

How many times does the Fed meet each year?

The FOMC holds eight meetings per year, typically scheduled every seven weeks. According to the Fed’s website, during these meetings the FOMC “reviews economic and financial conditions, determines the appropriate stance of monetary policy, and assesses the risks to its long-run goals of price stability and sustainable economic growth.”

How many more US Federal Reserve meetings this year?

As of August 21, three more Fed meetings are scheduled for 2025, and market participants will be closely watching these events.

It’s too soon to know what exactly the Fed will do at these remaining meetings, but its July statement gives some clues — in it, the central bank said that it “seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. Uncertainty about the economic outlook remains elevated. The Committee is attentive to the risks to both sides of its dual mandate.”

At the time, the Federal Reserve decided to hold rates steady at 4.25 to 4.5 percent for the fifth straight meeting as inflation remained elevated and job numbers appeared strong. The decision placed downward pressure on the gold price as a better economic outlook dimmed demand for the safe-haven asset.

While the current tariff war between the US and many of its major trading partners has some calling for a return to higher inflation, weak unemployment figures and other economic data published since the last meeting has caused others to consider the potential for a recession before the end of the year.

“At present, the latest economic data have been sufficiently mixed as to support either policy alternative,” according to analysts writing for the Peterson Institute for International Economics. “The case for a rate cut is driven by the pronounced slowing in job creation, the failure of inflation to respond much to the initial tariff increases, and the fact that most FOMC participants view the current stance of policy as slightly tighter than neutral.”