The Fed was the major newsmaker on Wall Street. On Sept. 18, the Federal Reserve announced it was cutting the federal funds rate by a half point to 4.75%, the first reduction in this key rate in four years, raising hopes the economy could ride out a prolonged housing slump and turmoil in the credit market.
The cut in the Fed's benchmark short-term rate, was more aggressive than many investors had expected. The market responded by rallying behind the rate cut and driving up the
Dow Jones industrials
more than 400 points on Sept. 18 and 19. Mortgage financers, mortgage insurers and housing-related stocks were among the biggest percentage gainers on the
The gain was short-lived, however, as the markets slowed on Sept. 20 and 21 after the Fed Chairman Ben Bernanke's appearance before the Committee on Financial Services in Washington, where he stated the
inflation rate is a major concern.
Those new to investing and The Stock Market Game program may be wondering how inflation affects one's investments. Inflation is the rate at which prices rise, and over time can erode the purchasing power of your money.
For example, you can buy somewhat less with a dollar today than you could have bought five years ago, and significantly less than you could have bought 50 years ago. So if you have the same amount of income each year, your purchasing power gradually shrinks.
Many factors influence the rate of inflation, from overall economic conditions and consumer spending to monetary policy and the political outlook.
Investing can help you offset the eroding effect of inflation by providing a rate of return on your money that's higher than the rate of inflation. If you expect your
portfolio to be worth more tomorrow than it is today in terms of buying power, you'll need to invest in
securities that have a good chance of outpacing inflation, but picking them is easier said than done.
Even more basic, what is the role of the Federal Reserve Bank and why does its policies have such a great impact on the overall economy and the individual investor?
The Federal Reserve System is the
central bank of the United States and plays many roles in the economy. The most important is regulating the money supply. This includes the currency in circulation, the reserves held by banks and the amount of money being deposited and redeposited in bank accounts.
The money supply is extremely important to individuals and businesses because the more money that's available, the easier and cheaper it is to borrow. The less money that's available, the more expensive borrowing becomes. The cost of borrowing, or the cost of credit, has a strong impact on whether the economy is able to grow or decline.
To keep the U.S. economy growing, the Fed focuses on achieving three goals: low inflation, high employment and moderate and stable long-term interest rates. Ideally, these three elements should work together, but often things get more complicated.
For instance, full employment may result in higher wages, which increase inflation. High inflation affects prices, but interfering with inflation may result in an economic slowdown. Therefore, the role of the Fed chairman is extremely important -- ensuring neither growth nor decline gets out of hand.
For more information about the Federal Reserve Bank and the role of the Fed chairman, be sure to check out the following
In The News
The Mystery of Mr. G
The Fed's Test
A Knight at the Fed
. All Stock Market Game newsletters are located in the
Teacher Support Center's Publications section and each of these issues does a great job explaining the Fed's role in influencing interest rates, spending and stock prices.
This article was written by a staff member of The Stock Market Game.