So, you may have heard something about the Fed increasing the rates this year. But what does that even mean?
The US Government's Federal Reserve Open Market Committee (FMOC or 'the Fed') controls the rate at which banks pay interest to the Federal Reserve for borrowing money. Why do the banks need to borrow money from the Fed? Because they must meet the federal mandate for banking reserves, which was set up after the Great Depression.
Just like we advise you to have a three- to six-months cushion of expenses put aside, the Fed advises banks to do the same. That is their reserve.
When a bank runs out of money, and it occasionally does happen, they can either borrow from another bank or the Fed to meet their minimum reserve. Borrowing from another bank would be easier and cheaper, but since there aren't too many banks left, they tend to run into difficulties (like being shut down by the Fed). Ever-changing regulations (set up by the Fed) coupled with mergers and little banks being swallowed up into big banks (okayed by the Fed) creates a situation where the Fed is the only place to turn to when reserves need to be met. Oh, and the Fed sets the reserve minimums.
So...does the Federal Reserve need money? Is that why they charge more interest? Nope! The Fed prints money, they don't need more -- they make it. And since we've departed from the Gold Standard, the US dollar is essentially valueless. We create it here, exchange it here, and the "value" is determined here by our market's supply and demand.
When the Fed raises interest rates, it makes it more expensive for banks to borrow money from them. Why would they do that? To make the supply of money smaller. With less money circulating, it becomes more valuable and people (you) will pay more for it in the form of loan interest for houses or cars.
Raising the interest rate is the way that the Fed manipulates the economy by either restricting or flooding the market with money.
What does it mean for you?
Prepare for an increase in borrowing rates for houses, cars, education, credit cards, rent, food, and anything you pay for with money. The Federal Reserve interest rate will be 3% by the end of 2018; it is currently 0.75%.