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Here's Why the Federal Reserve Raises or Lowers Interest Rates

By Motley Fool Staff – Mar 29, 2018 at 6:06PM

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What’s the point of the Federal Reserve’s interest rate actions?

Have you ever wondered why the Federal Reserve raises or lowers interest rates from time to time? In this Industry Focus: Financials clip, host Michael Douglass and banking specialist Matt Frankel give an overview of what the Federal Reserve is trying to accomplish with its monetary policy actions.

A full transcript follows the video.

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This video was recorded on March 26, 2018.

Michael Douglass: Let's also talk about this from another perspective. When the Fed makes a prediction, people listen. Understandably so. It's the Fed. This is what they're saying they plan to expect out of the economy, and a lot of market expectations are built into those predictions.

But, I also feel the need to point out, The New York Times published this lovely article in December of 2017, which I'm going to jokingly say was ambiguously titled, "When the Forecasters Get It Wrong: Always." Just to quote the article briefly here, "The consensus of leading economists has consistently missed big turns. They have not predicted a single United States recession since the Federal Reserve began keeping such records a half-century ago." So, when you think about that, people are human, people cannot predict the future. And frankly, it can be very difficult long-term to see where things are going. If you look at the history of the federal funds rate, which is the benchmark rate that the Fed sets, it peaked in late 2007, right before the massive financial recession that we have only somewhat recently gotten out of. It's worth pointing out here that predictions of the future are notoriously, well, inaccurate.

Matt Frankel: Yeah, even in that situation, in 2007, the Fed wasn't projecting a recession right around the corner.

Douglass: Right. Had it been, it would have done some things.

Frankel: Right. But, the Fed's goal is to have enough room to lower interest rates when it needs to and raise interest rates when it needs to, which is a big priority and why they want to get to that 3% range over the long run. This way, when a recession hits, they'll have some ammunition to lower the interest rate gradually and not immediately go to zero like we saw last time. The Fed likes to do things on a gradual basis. And as rates normalize -- right now they're still on the much lower end historically -- they'll have a little more ammunition to keep a stable economy, which is the ultimate goal of this.

Matthew Frankel has no position in any of the stocks mentioned. Michael Douglass has no position in any of the stocks mentioned. The Motley Fool recommends The New York Times. The Motley Fool has a disclosure policy.

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