"The Federal Fund Rate is the interest rate at which depository institutions lend reserve balances to other depository institutions overnight, on an uncollateralized basis.” What the f*ck? Yeah. I don’t get it either.
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George Fields - Understand
Ok. First what is an interest rate? An interest rate is a percent of a loan that is given out which is charged to the person or institution borrowing money. So for example if Bob wants to buy a house and takes out a loan of 100,000 dollars from Wells Fargo Bank, Wells Fargo may charge him an extra 5% of that $100,000 dollars to take the loan out - meaning that Bob actually owes the bank $105,000. The federal interest rate – also known as the federal fund rate – is the interest rate that banks charge each other for taking out overnight loans to meet their reserve requirement.
The reserve requirement is something made by the Fed that tells banks how much money they have to keep in their reserves. It’s usually about 10% of all deposits that bank customers make. So for every $100 dollars you deposit into your Bank of America account, B-of-A must only hold on to $10 dollars of it. What happens to the other $90? This is how banks make their money. They lend that money out to customers who may be looking for a new house, tuition for college, a new car or even to other banks and sometimes even to the government. Of course they charge interest rates on the money that you’ve given to them to lend out and they make money on your money. So what happens when a bunch of customers go to the bank and want a lot of money and the bank doesn’t have enough in its reserves to give it out? Well, when this happens banks can borrow money from the Fed or other banks that hold their reserves at the Fed. If the borrowing bank borrows from the Fed they are charged something called the discount rate - which is the same thing as an interest rate. If the borrowing bank borrows from another bank that keeps its money at the Fed it’s called the Federal Funds Rate – again the same thing as an interest rate.
So let’s say Wells Fargo runs out of money today because so many of its customers want to buy the new Call of Duty game that came out. Wells Fargo then will borrow money from another bank, say Bank of America, and be charged whatever the Federal Funds Rate is. Theoretically Wells Fargo will have to pay B-of-A back at the given interest rate.
So what happens when the Fed raises or lowers its rates? You hear about this in the news all the time and see news anchors freaking out about it on the regular. But why? When the Fed raises its rates it’s usually because it’s afraid of inflation – which is when prices increase while the value of money decreases. For example let’s say a pack of gum costs $1 today but inflation is occurring at 10% annually. In one year that same pack of gum will cost $1.10. You see, after inflation your dollar can’t buy the same pack of gum.
Some may think that when the Fed raises its rates it has a direct effect on the stock market. But that’s not the case. The rate simply makes it more expensive for banks to borrow money from the Fed or from each other. Of course, this creates a ripple effect which influences businesses, people and the stock market. Banks will now charge people more to borrow money – so for example mortgages and car loans become more expensive – which decreases the amount of money people have and affects businesses because people will spend less of their hard earned dough. Businesses are affected similarly – borrowing money becomes more expensive and limits business’ potential growth. Further down the ripple the stock market is also affected. When companies are seen as cutting back on its growth spending or are making less profit their stock prices generally drop. If enough companies experience this kind of decline then the entire stock market will go down.
Really, great video. I guess the only thing I could say to make it even better is to make it more explicit when you migrate from one subtopic to another ( like the money creation, etc) and the relation that they have with the main topic
I'm seeing one error already: banks don't depend on their deposits to give out loans. They depend on their asset to liability ratio.
Oke I'm seeing an other error, look at positive money how most of our money gets created https://youtu.be/KvpbQlQwl0A.
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