Why Does the US Federal Reserve Hike 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.

How does the US Federal Reserve regulate monetary policy?

The Fed regulates monetary policy and the financial system by setting interest rates, as well as influencing money supply and — as it has done recently — boosting the financial markets by making asset purchases worth trillions.

Buying and selling US Treasury bonds to control bank reserves and interest rates is one of the strategies the Fed employs to meet its dual mandate of stable prices and stable employment.

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. Rising inflation and high unemployment are two of the biggest threats to monetary stability.

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.

In the face of rising inflation, the Fed raises interest rates in the hopes of reigning in rapidly rising prices by curbing demand. The Fed’s goal is to keep inflation around its target rate of 2 percent. When interest rates are higher, borrowing money becomes more expensive, which ultimately slows consumer spending and curtails corporate growth.

“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.

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

In an effort to fight inflation, the American central bank has been consistently increasing rates since its March 2022 boost of 25 basis points. Its hike of 75 basis points last June was at the time its largest since 1994.

The Fed has now raised interest rates by 4.75 percentage points since March 2022.

How many times does the Fed meet each year?

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.

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?

Several more Fed meetings are scheduled for 2023, 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 March statement gives some clues — in it, the central bank says that it "anticipates that some additional policy firming may be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time."

However, the current banking crisis in the US has caused the Fed to consider the potential for a recession by the end of the year.

"Events in the banking system over the past two weeks are likely to result in tighter credit conditions for households and businesses, which would in turn affect economic outcomes,” Fed Chair Jerome Powell said during a press conference after the meeting. “As a result, we no longer state that we anticipate that ongoing rate increases will be appropriate to quell inflation. Instead, we now anticipate that some additional policy firming may be appropriate.”