A:

Inflation and interest rates are linked, and frequently referenced in macroeconomics. Inflation refers to the rate at which prices for goods and services rises. In the United States, interest rates are determined by the Federal Reserve (sometimes called "the Fed").

In general, as interest rates are lowered, more people are able to borrow more money. The result is that consumers have more money to spend, causing the economy to grow and inflation to increase. The opposite holds true for rising interest rates. As interest rates are increased, consumers tend to save as returns from savings are higher. With less disposable income to spend as a result of the increase in savings, the economy slows and inflation decreases.

The Federal Open Market Committee (FOMC) meets eight times each year to review economic and financial conditions and decide on monetary policy. Monetary policy refers to the actions taken that affect the availability and cost of money and credit. At these meetings, short-term interest rate targets are determined. Using economic indicators such as the Consumer Price Index (CPI) and the Producer Price Indexes (PPI), the Fed will establish interest rate targets intended to keep the economy in balance. By moving interest rate targets up or down, the Fed attempts to achieve target employment rates, stable prices, and stable economic growth. The Fed will raise interest rates to reduce inflation and ease (or decrease) rates to spur economic growth.

Investors and traders keep a close eye on the FOMC rate decisions. After each of the eight FOMC meetings, an announcement is made regarding the Fed's decision to increase, decrease or maintain key interest rates. Certain markets may move in advance of the anticipated interest rate changes and in response to the actual announcements. For example, the U.S. dollar typically rallies in response to an interest rate increase, while the bond market falls in reaction to rate hikes.

RELATED FAQS
  1. When was the last time the Federal Reserve hiked interest rates?

    Learn about when the U.S. Federal Reserve last increased the federal funds target rate, which was in June 2006 after the ... Read Answer >>
  2. What are the implications of a low Federal Funds Rate?

    Find out what a low federal funds rate means for the economy. Discover the effects of monetary policy and how it can impact ... Read Answer >>
  3. How do open market operations affect the U.S. money supply?

    Formulating a country's monetary policy is extremely important when it comes to promoting sustainable economic growth. More ... Read Answer >>
  4. What is the Difference Between Real and Nominal Interest Rates?

    Learn what nominal interest rates and real interest rates are, how real interest rate takes into account the inflation rate, ... Read Answer >>
Related Articles
  1. Insights

    How Interest Rates Affect The U.S. Markets

    Interest rates can have both positive and negative effects on U.S. stocks, bonds and inflation.
  2. Insights

    Why the Fed Keeps Lowering Macro Growth Outlook

    Examine the FOMC's communications to determine when and why it has reduced its growth expectations. Find out how changing forecasts impact interest rate hikes.
  3. Financial Advisor

    How the Fed Fund Rate Hikes Affect the US Dollar

    Learn about the effects the federal funds rate on the U.S. dollar. Understand what happens when the Federal Reserve increases interest rates.
  4. Trading

    How Interest Rates Affect The U.S. Markets

    When indicators rise more than 3% a year, the Fed raises the federal funds rate to keep inflation under control.
  5. Insights

    How the Federal Reserve Affects Individual Investors

    The Federal Reserve's decision on interest rates affects the whole economy.
  6. Personal Finance

    How Interest Rate Cuts Affect Consumers

    Traders rejoice when the Fed drops the rate, but is it good news for all? Find out here.
  7. Financial Advisor

    Implications of the Federal Reserve's Impending Rate Hike

    The Federal Reserve begins its two-day meeting on Wednesday, September 16, and everyone is watching to see if the central bank will raise the United States target interest rate for the first ...
  8. Insights

    What Does the Federal Reserve Do?

    What is the Federal Reserve System and how does it affect interest rates, inflation and the market?
  9. Trading

    Understanding the Federal Open Market Committee

    The Federal Open Market Committee is the branch of the Federal Reserve Board that determines monetary policy.
RELATED TERMS
  1. Target Rate

    The interest rate charged by one depository institution on an ...
  2. Federal Open Market Committee Meeting - FOMC Meeting

    The meeting of the Federal Open Market Committee (FOMC) that ...
  3. Key Rate

    The specific interest rate that determines bank lending rates ...
  4. Real Interest Rate

    An interest rate that has been adjusted to remove the effects ...
  5. Tight Monetary Policy

    A course of action undertaken by the Federal Reserve to constrict ...
  6. Federal Open Market Committee (FOMC)

    The FOMC is the branch of the Federal Reserve Board that determines ...
Hot Definitions
  1. Fixed Cost

    A cost that does not change with an increase or decrease in the amount of goods or services produced. Fixed costs are expenses ...
  2. Blue Chip

    A blue chip is a nationally recognized, well-established, and financially sound company.
  3. Payback Period

    The length of time required to recover the cost of an investment. The payback period of a given investment or project is ...
  4. Collateral Value

    The estimated fair market value of an asset that is being used as loan collateral. Collateral value is determined by appraisal ...
  5. Fiduciary

    A fiduciary is a person who acts on behalf of another person, or persons to manage assets.
  6. Current Account

    The difference between a nation’s savings and its investment. The current account is defined as the sum of goods and services ...
Trading Center