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To: calgal who wrote (140410)	8/24/1999 7:04:00 PM
From: stockman_scott	Respond to of 176387

~OT~ LW: FYI...Everything you wanted to know about the Fed Action.... <<FED RATE ALERT +-+-+-+-+-+-+-+-+-+-+-+-+-+ Federal Reserve hikes fed funds and discount rate a quarter point By Michael D. Larson -- bankrate.comSM If enough people have the same wish it sometimes comes true or so the latest Federal Reserve Board rate action suggests. At its policy-setting meeting Tuesday the Fed gave people exactly what they wanted by raising the two rates it controls by a relatively benign 25 basis points. The federal funds rate will climb to 5.25 percent from 5 percent as a result of the move while the federal discount rate will rise to 4.75 percent from 4.5 percent. The last time it met in June the Fed raised the funds rate by 25 basis points but left the discount rate alone. The Fed also announced that it will maintain its neutral "bias" toward interest rates for now. That means the agency doesn't see a need to raise or lower rates in the immediate future. Today's increase in the federal funds rate, together with the policy action in June and the firming of conditions more generally in U.S. financial markets over recent months, should markedly diminish the risk of rising inflation going forward, the Fed said in its announcement. "As a consequence the directive the Federal Open Market Committee adopted is symmetrical with regard to the outlook for policy over the near term." In explaining its actions the committee pointed out that the three rapid-fire rate decreases it put in place last year are no longer necessary. They were put in place to make sure a Russian debt default and other economic crises abroad didn't derail our economic expansion and recent reports show Americans are doing just fine thank you. At the same time the Fed wants to make sure that extremely tight labor markets here don't cause inflation to surge. That can happen if companies have to raise wages too much in order to attract workers. Firms typically raise the prices they charge for their products to consumers in order to compensate. Understanding the news The Fed increase will quickly show up in the rates for home equity lines of credit car loans savings accounts and credit cards. How quickly depends on the product with rates ratcheting up within days for some (such as variable-rate credit cards) and within weeks for others (such as car loans). Mortgage borrowers though don't enjoy a rate-hike honeymoon at all. Because economic data released over the course of the summer suggested the Fed would raise rates mortgages rates climbed in anticipation of the move. To understand what's behind the increases you need to understand the rates at issue. The Federal Reserve can influence the economy by changing the discount rate or the funds rate. Although those rates are very different a change in either has the same effect: Increases slow the economy and prevent inflation; decreases spur economic growth. Either way it affects your budget. Changes in the discount rate -- the rate at which the Fed lends to banks -- generally have been infrequent. From 1980 through 1990 for example there were only 29 rate changes. However the moves tend to come in flurries. The Fed cut the discount rate seven times in a period of economic sluggishness from December 1990 to July 1992 -- from 7 percent ultimately to 3 percent. From May 1994 to February 1995 when the Fed was concerned about the threat of inflation it raised the discount rate four times -- from 3 percent to 5.25 percent. The last time the discount rate changed was last fall when the Fed cut it by 50 basis points. The rate had remained at 4.5 percent since last November. How the funds rate works The funds rate works differently. Banks do not earn any interest on the money they are required to have on deposit with the Federal Reserve. When reserves climb above the minimums required banks gladly loan out that excess to other banks that need to add money to their reserves. The lending banks charge interest for this service. The rate of interest they charge is known as the "federal funds rate or funds rate. This rate jumps around all the time. The Federal Reserve sets the base or benchmark rate that banks charge. If Fed policies cause this rate to increase, the cost is passed on to the end user -- the customer. The last time the Fed jumped in and changed the rate was in June, when the Fed raised the rate to 5 percent in order to slow the economy a bit. Because the funds rate is the rate charged between two banks, it is also subject to market conditions. If there is a lot of demand for funds, banks can charge a higher rate. This negotiation goes on all day long, making the funds rate one of the most volatile national rates. Direction is critical When a Fed change is announced, the direction (up or down) of the change is critical. Increases in the discount rate generally reflect the Federal Reserve's concern about inflationary pressures, while decreases often reflect a concern about economic weakness. How does this affect you? Think of the bank as a wholesaler. If it costs your bank more to borrow, that cost is passed on to you. If the rate drops, those savings are also passed along. This is most frequently done in the form of the bank's prime rate. The prime rate is the rate charged by a bank to its best or prime, customers. It is often used as an index, or a base rate, for home equity loans, home equity lines of credit and credit cards. Therefore, when the prime rate changes, the rate you are charged for those loans will adjust accordingly. If your rate goes up, so will your payments. It also has a positive effect in that banks pay you more for your deposits. What to expect from an increase Now, without delving too deeply into monetary policy, let's look at what you need to know as a consumer. A newspaper headline reads: Greenspan says increase near." Translation: The chairman of the Federal Reserve Board of Governors Alan Greenspan thinks along with his fellow FOMC members that the economy is growing too fast. If the economy is growing fast then inflation will set in. Inflation increases everyone's cost of living. The Fed doesn't want this so the committee increases the discount rate the funds rate or both. The banks pass the increased cost of doing business along to the ultimate users of credit -- consumers. How do consumers react? The increased cost of credit makes the monthly payment on that new refrigerator too high. As a result they don't buy it this month. The stores don't sell their inventory as quickly and they cut back on factory orders. The factory doesn't get as many orders so management slows down the assembly lines. They don't want to produce goods they cannot sell. Factory workers put in less overtime or they get laid off. They don't have as much money to spend so they cannot buy as much. The cycle continues and the economy slows down inflation is averted and Greenspan and his fellow board members enjoy the warm glow of knowing they have saved us from destruction. Capital markets react There is a secondary effect to any change or even rumored change in Fed policy. It affects all of the capital markets (stocks and bonds). The Fed by making a change in the rates is in fact making a statement about the economy. This causes all of the capital markets to shift their rates to meet the Federal Reserve' s expectations. Therefore an increase in the Fed rates will cause the capital markets to increase the required rates on all types of stocks and bonds including U.S. Treasury obligations and mortgage-backed securities made up of bundled home loans. That sends mortgage rates charged to consumers higher.>>