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 are higher. With less disposal 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 maximum employment, stable prices and stable economic growth. The Fed will raise interest rates to reduce 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.

  1. Do lower interest rates increase investment spending?

    Learn how the Federal Reserve Board uses monetary policy and the federal funds rate to influence long-term interest rates ... 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. What happens if interest rates increase too quickly?

    Learn about what happens if interest rates rise too fast and understand what goes into the Fed’s decision to adjust interest ... Read Answer >>
  4. 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 >>
  5. 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 >>
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  1. Key Rate

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