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. Who determines interest rates?

    In countries using a centralized banking model, interest rates are determined by the central bank. In the first step of interest ... Read Answer >>
  2. How do changes in interest rates affect the spending habits in the economy?

    Examine the factors that typically determine how consumers react to interest rate changes in terms of increasing their levels ... Read Answer >>
  3. How do central banks impact interest rates in the economy?

    Learn how central banks such as the Federal Reserve influence monetary policy in the economy by increasing or decreasing ... 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 >>
  5. Can real interest rates be negative?

    Discover the circumstances that can cause real interest rates to be negative and learn how to calculate the values of real ... Read Answer >>
  6. How does the Fisher effect illustrate returns on bonds?

    Learn how the Fisher effect shows the impact of expected future increases in inflation on the prices of bonds and their interest ... 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. Investing

    How Do Interest Rates Affect the Stock Market?

    Interest rates can have a complicated ripple effect through financial markets. Here's what you need to know.
  3. 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.
  4. 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.
  5. Insights

    How the Federal Reserve Affects Individual Investors

    The Federal Reserve's decision on interest rates affects the whole economy.
  6. Financial Advisor

    What's the Fed Going to do in 2016?

    Learn about the factors that contribute to increases in the federal funds rate by the Federal Reserve and key economic indicators for 2016.
  7. Insights

    When Will Interest Rates Rise?

    Find out if -- and why -- the Federal Reserve will keep raising interest rates and what that might mean for savers, investors and the entire economy.
  8. Investing

    Are The Markets Ready For an Interest Rate Increase?

    Learn why the bond market may not necessarily see an interest rate increase soon. Read about how the Federal Reserve will slowly raise interest rates.
  9. Investing

    Forces Behind Interest Rates

    Interest is a cost for one party, and income for another. Regardless of the perspective, interest rates are always changing.
RELATED TERMS
  1. Target Rate

    The interest rate charged by one depository institution on an ...
  2. Real Interest Rate

    An interest rate that has been adjusted to remove the effects ...
  3. Federal Open Market Committee Meeting - FOMC Meeting

    The meeting of the Federal Open Market Committee (FOMC) that ...
  4. Inflation

    The rate at which the general level of prices for goods and services ...
  5. Reference Rate

    An interest rate benchmark upon which a floating-rate security ...
  6. Cost Of Funds

    The interest rate paid by financial institutions for the funds ...
Hot Definitions
  1. Straddle

    An options strategy in which the investor holds a position in both a call and put with the same strike price and expiration ...
  2. Trickle-Down Theory

    An economic idea which states that decreasing marginal and capital gains tax rates - especially for corporations, investors ...
  3. North American Free Trade Agreement - NAFTA

    A regulation implemented on Jan. 1, 1994, that eventually eliminated tariffs to encourage economic activity between the United ...
  4. Agency Theory

    A supposition that explains the relationship between principals and agents in business. Agency theory is concerned with resolving ...
  5. Treasury Bill - T-Bill

    A short-term debt obligation backed by the U.S. government with a maturity of less than one year. T-bills are sold in denominations ...
  6. Index

    A statistical measure of change in an economy or a securities market. In the case of financial markets, an index is a hypothetical ...
Trading Center