Most people have a pretty good idea about what the Federal Reserve does. In fact, when asked, 73% of Americans correctly say that the Fed is primarily responsible for monetary policy. But when it comes to being sure about the Fed’s policy influence on things like interest rates and inflation, only 27% find that easy to understand.

With the economy, inflation and consumer sentiment all in the headlines right now, we’re continuing our two-part series on inflation this week. Read on as we delve into the Fed’s role and how its policymaking affects everything from borrowing to savings.

What does the Fed have to do with inflation?

In some ways, the Federal Reserve is like a watchdog of the U.S. economy. Part of its job is to keep prices stable — rather than having them rise or fall too fast — thereby keeping inflation in check.

The Fed’s so-called sweet spot (or what it considers the “just-right” amount) is typically a rate of inflation of 2% per year. This is measured by the consumer and producer price indexes we discussed in Part 1.

So, how does it balance this level? As the central bank, the Fed tries to control inflation by influencing interest rates. When inflation is too high, for example, it typically raises interest rates to slow the economy and tamp inflation down. When inflation is too low, it usually lowers interest rates to stimulate the economy and nudge inflation higher.

What measures should you watch now?

Overall, concerns about the Delta variant’s surge are leading economists to predict the Fed could delay action (possibly by at least a month or two) intended to better align the pace of economic recovery. The latest key markers show:

• Job growth slowed considerably in August, with the economy adding far fewer jobs than expected.
• Consumer confidence also waned in August, falling to its lowest level since February 2021.

What do these indicators mean? Consumer optimism and the Fed’s goal of maximum employment appear to be a ways off, so an interest-rate hike will still be on the back burner.

How can inflation and interest rate moves affect you?

Inflation can impact everyone. But deflation (the opposite of inflation) does, too. When inflation is high, your money may not stretch as far as it used to. When it’s low, your purchasing power increases.

Paying less for what you need may sound great, but there can be some downsides along with the upsides. That’s because the inflation/deflation cycle affects a lot more than prices for the things you buy.

One reason is that there’s a lot of inherent unpredictability in inflation regarding what we can expect in the future. So, inflation that ends up higher or lower than expected can shift the playing field, for instance, among borrowers and lenders. And it can add some uncertainty when making savings and investment decisions.

For example, the money in your savings accounts might earn less during times of deflation because interest rates on deposits tend to head south. On the flip side, inflation may produce just the opposite swing. Diversifying your investments can help stabilize these effects.

Or, say you took out a low-interest loan to help make a big buy that seemed to be a great deal. Next year, you notice the price of that purchase you made went up (due to inflation). In this case, you’ve got the advantage because you’re paying back the loan based on the lower price.

What should you keep in mind in the near term?

When it comes to inflation, everything revolves around balance. By moving interest-rate targets up or down, the Fed tries to achieve stable economic growth with a comfortable amount of inflation.

If you’re considering financing a high-value purchase or are looking to ensure your savings earn a competitive rate, keep these essential facts in mind:

• ●Interest rates affect the cost of borrowing money over time, and lower rates can make borrowing cheaper.
• ●Higher rates make borrowing more expensive, and an increase in interest rates may make the rate of return on savings more attractive.