There is one story that you are likely to keep on encountering, even as you turn through the business news sections of major newspapers. That is the story about the fed rate hike. The story started making headlines toward the end of the year 2015, and it is likely to keep on having a major impact in the year 2016. Everyone seems to be talking about the fed rate hike. For someone who is not conversant with these things, the entire thing can be confusing: as one tries to understand what the fed rate is, and why a fed rate hike is such a big deal. Aware of this need, in today’s blog post, I will attempt to shed light on the fed rate hike, and explain why the fed rate hike is such a big deal (if the business news reports are anything to go by).
So we start by trying to understand what the fed rate is, in the first place. In that regard, we get to learn that the fed rate – whose full name is the federal funds rate — is the interest rate at which banks lend money to each other ‘overnight’. This rate is set not by the banks, but rather, by a highly influential committee known as the Federal Open Market Committee.
Turning to the question of why the fed rate hike is such a big deal, you have to understand that when the fed rate is hiked, several things tend to happen. Firstly, when the fed rate is hiked, the value of the dollar tends to go up (meaning that other currencies depreciate, against the dollar). Secondly, when the fed rate is hiked, the supply of money in the economy tends to get contracted. Thirdly, when the fed rate is hiked, investors who were previously inclined to invest in foreign markets tend to be inclined to invest in the USA. It is for these reasons, then, that the fed rate hike is such a big deal. It is also for those reasons that the fed rate hike is attracting so much coverage in various news publications.