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 – the amount of interest paid by a borrower to a lender – are set 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 have less money to spend. With less spending, 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 maximum employment, stable prices and stable economic growth. The Fed will tighten interest rates (or increase rates) to stave off inflation. Conversely, the Fed will 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.

RELATED FAQS
  1. How does macroeconomics explain "stagflation"?

    The terminology best used to describe a period when the economy experiences stagnation accompanied by inflation is otherwise ... Read Full Answer >>
  2. What are the best ways to sell an annuity?

    The best ways to sell an annuity are to locate buyers from insurance agents or companies that specialize in connecting buyers ... Read Full Answer >>
  3. Is Argentina a developed country?

    Argentina is not a developed country. It has one of the strongest economies in South America or Central America and ranks ... Read Full Answer >>
  4. How is the Federal Reserve audited?

    Contrary to conventional wisdom, the Federal Reserve is extensively audited. Politicians on the left and right of a populist ... Read Full Answer >>
  5. Who decides when to print money in the US?

    The U.S. Treasury decides to print money in the United States as it owns and operates printing presses. However, the Federal ... Read Full Answer >>
  6. Why do some people claim the Federal Reserve is unconstitutional?

    The U.S. Constitution does not mention the need for a central bank, nor does it explicitly grant the government the power ... Read Full Answer >>
Related Articles
  1. Investing

    What’s Holding Back the U.S. Consumer

    Even as job growth has surged and gasoline prices have plunged, U.S. consumers are proving slow to respond and repair their overextended balance sheets.
  2. Economics

    The Problem With Today’s Headline Economic Data

    Headwinds have kept the U.S. growth more moderate than in the past–including leverage levels and an aging population—and the latest GDP revisions prove it.
  3. Economics

    Explaining the Participation Rate

    The participation rate is the percentage of civilians who are either employed or unemployed and looking for a job.
  4. Economics

    What Qualifies as Full Employment?

    Full employment is an economic term describing a situation where all available labor resources are being utilized to their highest extent.
  5. Fundamental Analysis

    Is India the Next Emerging Markets Superstar?

    With a shift towards manufacturing and services, India could be the next emerging market superstar. Here, we provide a detailed breakdown of its GDP.
  6. Investing News

    Timing of the Fed Interest Rates Hike

    Until the beginning of August, Fed watchers expected the central bank to raise rates in September. However, recent news pertaining to China’s slowing economy and its devaluation of the yuan have ...
  7. Economics

    A Look at Greece’s Messy Fiscal Policy

    Investigate the muddy fiscal policy, tax problems, and inability to institute austerity that created the Greek crises in 2010 and 2015.
  8. Markets

    The Vodka Industry Keeps Growing, But Why?

    Understand what the vodka industry is and where it performs best. Learn about the growth of the industry and three reason why it continues to grow.
  9. Term

    What is the Macro Environment?

    The macro environment is the conditions existing in an economy as a whole, rather than in a single sector or region.
  10. Term

    Understanding the Maintenance Margin

    A maintenance margin is the minimum amount of equity that must be kept in a margin account.
RELATED TERMS
  1. Monetary Policy

    The actions of a central bank, currency board or other regulatory ...
  2. Cost, Insurance and Freight - CIF

    A trade term requiring the seller to arrange for the carriage ...
  3. International Monetary Fund - IMF

    An international organization created for the purpose of standardizing ...
  4. Inflation

    The rate at which the general level of prices for goods and services ...
  5. Delivered Duty Unpaid - DDU

    A transaction in international trade where the seller is responsible ...
  6. Marginable

    Definition of "marginable."

You May Also Like

Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!