What investors need to understand about the Federal Reserve monetary policy

Every developed nation has a monetary policy. It is its strategy for how its central banks circulate money in the economy, and what that money is worth. This looks different for many countries. For example, the monetary policy of the Bank of Canada is to keep inflation at nearly 2% to promote a productive and growing economy. 

In the U.S., the Federal Reserve monetary policy typically aims to promote maximum employment, moderate long-term interest rates and stable prices in the economy. Decisions on how to achieve these goals are made by the Federal Open Market Committee (FOMC).

How does the U.S. Federal Reserve monetary policy affect investors?

The U.S. Federal Reserve monetary policy has maintained a 2% inflation target rate for years, but because of COVID-19, the Federal Reserve will allow inflation to run above 2% for some time in the future to allow things to balance back out. 

When the economy is growing slow or inflation is low, the banks may lower short-term interest rates to help stimulate the growth of the economy back toward the target of an average growth of 2%. This means that investors may want to seize the opportunity to capitalize on short-term investments with lower interest rates as part of their portfolio.

Conversely, when the economy is growing too fast and inflation is increasing at a rapid rate, the Federal Reserve may raise short-term interest rates to help stunt the growth and keep inflation at a healthy rate of growth.

During these times, investors may want to shift their portfolios more into long-term investments.

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