How much you earn on a money market account comes down to a few important factors. Here's how it works.
The Federal Reserve (commonly referred to as the "Fed") is the U.S. government's central bank. Its purpose is to keep the U.S. economy generally stable, and it has the power to set some economic policies toward that goal. Within the Fed is a group called the Federal Open Market Committee (FOMC) -- they're the decision makers. The FOMC consists of 12 members:
The board meets eight times each year. One of their tasks is deciding whether there should be any changes in the federal funds rate -- that's the interest rate banks charge when they lend money to each other.
When the economy is moving toward recession, this committee lowers the federal funds rate. That makes it cheaper for banks to borrow money, and can help get the economy moving when things are slow. When the economy is growing too quickly, the FOMC raises the federal funds rate to keep that growth under control.
A president-elect may hope the interest rate will rise or fall, but he doesn't have the authority to demand change. It is the Federal Reserve (commonly referred to as the "Fed") that determines rate changes. That's not to say a president-elect plays no role in setting the federal funds rate. The FOMC attempts to predict each new president's actions, and changes the federal funds rate accordingly. Their goal is to predict whether proposed policies are likely to lead to economic growth.
However, the potential actions of a president-elect are just one small factor in the FOMC's decision-making process. The driving influence is how a rate change will impact the economy, based on everything going on in the U.S. and internationally.
Banks use the federal funds rate as a benchmark to decide rates for deposit accounts, loans, and more. When the federal funds rate goes up, banks' rates go up, too: Savings accounts earn more interest, and loans charge more interest. When the federal funds rate goes down, banks' rates go down.
One attractive feature of a money market account is that you lock in the interest rate when you open an account. So even if the Fed drops its rate and the prime rate follows, you get the same earnings for the entire term.
When your bank decides on interest rates for money market accounts (or other interest-bearing products), they decide how much over the federal funds rate they are willing to pay depositors. Let's imagine that the federal funds rate is 0.25%. If your bank offers 0.50% interest on a money market account, that means you're receiving 0.25% over the federal funds rate.
The interest rates quoted on money market accounts vary by financial institution because each sets its own rate based on the federal funds rate.
If you are in the market for a money market account, there are a few things you should pay attention to. Some of these include:
Money market accounts can be an attractive place to keep money. They typically offer higher-than-savings interest rates, check-writing and debit-card privileges, and FDIC insurance. They are not for everybody, though. Here are two issues that may be considered drawbacks:
Ultimately, the Federal Reserve's rate decisions determine whether we can afford to buy a home, use credit cards, or take out a personal loan to remodel the kitchen. It's also the Fed's rate that sets the foundation for how much we earn on deposits, including money market accounts.
If you want to know what's likely to happen to interest rates in the near future, it's as easy as paying attention to what the Fed does next.
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