Larry Ludwig from Investor Junkie is our guest today to explain what the Federal Reserve is, does, and why you need to know.
Put simply, the Fed sets monetary policy and either adds or removes money from the system. There are twelve regional Feds across the country to help manage local banks. It was created in 1913 as a way to prevent feature economic disasters. Bit of a fail I think.
The chairperson is appointed by the president but is supposed to operate independently of the government. Prior to 1971, we operated on the gold standard so the Fed made sure the amount of money matched the amount of gold. Now we operate on a “faith based” system where we rely on the government to determine the value of money.
In order to help stimulate the economy after the crash, the Fed allowed banks to borrow money at 0% interest. The rate has been that low for seven years. Lowering the interest rates is meant to stimulate the economy. When rates are low, people can borrow money to buy things they couldn’t afford before. When interest rates are raised, that means that the economy is doing well and is at nearly full employment.
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The Fed is also tasked with keeping inflation/deflation in check. They have not always been successful but the average rate of inflation has been about 3% since the Fed’s creation.
The Fed also determines how much cash banks must have in reserve.
Ultimately it’s productivity that grows an economy and not slight of hand by the Fed. And a lot of economists consider all this smoke and mirrors to be merely kicking the can down the road, just delaying the next 2008 style melt down.
Is the Fed good or bad? That’s up for debate. The Fed has helped pull us out of crisis but did they create the crisis in the first place? Are they creating artificial cycles?
What can you do to protect yourself against the whim of the Fed? Make sure to have a good asset allocation strategy. Aside from that and repatriating, there isn’t much else you can do.
It’s good to understand the Fed but ultimately, invest your money in the LMM set it and forget it style and don’t worry too much about what they are doing.
White Beer: A crisp, summer beer.
Investor Junkie: Larry’s site dedicated to helping you become a better investor.
The Creature from Jekyll Island: A look at the Federal Reserve.
Betterment: Don’t worry about the Fed and invest your money.
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