Why does the Fed change the interest rate?


The U.S. Federal Reserve building in Washington, D.C. See more images of Washington, D.C.
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You hear about it a few times a year: The Fed has raised interest rates, or the Fed delivered an interest rate cut after its latest meeting. Excited, you go to your local bank to check out its brand-new rates on car loans. To your disappointment, they're the same as they were yesterday. What gives?

The Fed, formally known as the Federal Reserve Bank, does have a tremendous amount of power. It can just take awhile to trickle down -- which would explain your disappointment over your bank's rates.

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The Federal Reserve Bank is a group of interrelated private corporations, independent from (but entirely enmeshed in) the U.S. government, that controls the movement of money throughout American finance. The Fed actually used to control the amount of money available to circulate. But these days, it has the same effect without having to turn the money spigot on and off. Economists still keep an eye on the amount of money in circulation, called money aggregates. This refers to where Americans are keeping their money.

The aggregates most closely watched are in the form of things like currency and checking accounts, as well as savings accounts and mutual funds. Economists use these as a measuring stick when they make decisions regarding monetary policy [source: FRBSF]. These are the places where money can be most easily spent -- it's easier to write a check than it is to cash a bond. In 2002, the use of this indicator was discontinued as a tool for making sweeping economic decisions.

This makes life for Fed Chairman Ben Bernanke even more difficult. Bernanke's job is among the most stressful in the world. To be a Fed chairman, one must be an "oracle" [source: CNN Money]. Bernanke is responsible for the economic health of Americans -- from the assembly line worker to the major investment banker. With so much at stake, why would the Federal Reserve bother changing anything at all?

Read about the delicate nature of interest rate adjustments on the next page.