By raising interest rates, the Federal Reserve hopes to tackle high prices and reduce demand by making it more expensive to borrow money.
The reasons the U.S. is in this economic environment, but can be boiled down simply: There is too much demand and not enough supply. As Federal Reserve Chairman Jerome Powell said Wednesday:
When you get a loan from a bank -- for example when you're buying a house, an interest rate is attached to that loan. The interest rate is the price you pay to borrow the money. When banks need to borrow money to replenish those reserves, they look to other banks that have reserve accounts with the Fed and that may be in a surplus.
The best example is the prime rate. This is the interest rate banks charge their most creditworthy borrowers, like large corporations. For several decades now, the rule of thumb has been that the prime rate is equivalent to the federal funds rate plus 3%. So, with the new federal funds target rate at between 1.5% and 1.75%, the new prime rate at the upper range would be at 4.75%. The percentage difference is supposed to cover the cost of processing a bank loan.
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