Yesterday I was talking economics with Greg and that prompted some research and thinking into the subject of just what effect things like the Federal Reserve’s interest rate adjustments really have. So, in an effort to show the world how ignorant I really am, I’m going to write up some of what I think I might know about this. 
From what I gather, when the Fed adjusts that number you always hear about in the news, they are effectively controlling the value of money itself. The rate they usually adjust is the cost for a bank to borrow money from the Fed. The reason this is important is because that indirectly affects all the usual rates of interest you’re used to hearing about - like credit cards, some mortgages, car loans, etc. If the Fed rate is high when you get a loan, your interest rate will be similarly high and vice versa.
The interest rate the Fed charges cuts into the profits the bank can make by loaning more money, so in order for the bank to make a profit, they have to charge their customers more to use the money they borrowed themselves in order to lend out again. Borrowers are the real customers of banks - this is why they are always so eager to loan money.
Banks pay interest on savings accounts because they are using the deposited money and loaning it out to others. The saver gets paid for that service because the money is actually a commodity they are consuming in order to do business with the people who want more money than they have. When interest rates go up, banks start wanting more people to save with them and so they start offering CDs and other savings vehicles with higher interest rates. Why? Because it becomes cheaper to get money from the public than it is to go to the Fed!
It’s not to say that a person with money wants higher interest rates, though. It’s much more complex than that because the rates paid by banks are much lower than other investment types - such as the stock market. Since companies use money too, they are affected by the cost of it in ways similar to banks. The difference for them is that higher interest rates may mean they cannot afford to borrow as much which means they may not be able to grow as quickly as they’d like. This naturally results in a decrease in profits and/or growth which affects their stock prices which in turn adversely affects how much an investor in that company’s stock can ultimately make over time.
Often the news will report that the Fed is cutting interest rates in order to fight inflation. Inflation is bad, of course, because it means that $1 yesterday was worth more than $1 today. Obviously it is in everyone’s interest to avoid inflation. So what is inflation, exactly? I understand there are several schools of thought, but the one that seems to make sense to me is that inflation is something like the absolute value of the difference between goods people want to buy and money available to buy it. What this means if that if there’s more money than there are things people and companies want to buy, prices go up because companies see this surplus of money and start increasing their profits by taking more of the customer’s money. On the other hand, if there’s not enough goods to meet the demand (think oil), the prices go up because it’s harder/more expensive to get and therefore worth more to the buyer. In order for this to make sense, you have to think of money itself as a commodity that also takes part in the supply and demand equation.
So from what I can tell, for the last year or two the Fed has been operating under the assumption that the problem in our economy was being caused by a lack of goods and so they cut interest rates in order to promote people to buy more, companies to make more, etc. The theory would be that if there’s more stuff to buy, then inflation will go down and the economy will get moving again. But it hasn’t been working. So they have two options now: 1) raise the interest rates, or 2) leave them alone.
Raising interest rates means the cost of money goes up and production would likely drop. If this is what the Fed does, then it is my theory that they are suggesting that the system has too much money available rather than too many goods and services. Increasing interest rates should cause people and companies to borrow less and thus reduce the amount of money available for purchases in the system. It should also encourage people and companies in debt to repay those loans before the rates go up even higher. My theory is that this is the action we need to fix the current mess - as unpopular as that may be.
If they choose to leave the rate the same, then I think that suggests they are either playing political games (raising interest rates always seems “bad” in the public’s eye), or that they aren’t sure themselves and they want to play a wait-and-see game (which is a copout, IMO). I think the only way this could turn out well is if the ratio of money vs. goods isn’t teetering on the edge of balance that it appears to be.
My guess is that we’re on the verge of entering a time of stagflation - which is when inflation goes up, but there’s very little economic growth to show for it. Historically, they are apparently rather difficult to break because they are a bit like a self-sufficient cycle. Inflation causes prices to rise, and rising prices means it becomes too expensive to grow the economy, but since companies have to make a profit, they raise prices. Rinse and repeat. The only way out is to disrupt the balance or stop trying to grow. Since public companies have what amounts to a legal imperative to generate a profit, they have no choice but to keep trying to grow. This means something needs to change or else their attempts at growth will drive inflation to insane heights as they spin their wheels in the mud.
The Fed appears to be very conservative, so I suspect that at their next meeting they won’t change a thing. That means it’ll be another several months before anything changes unless they get lucky in their inaction and the market corrects itself. How could it correct? Well, one way is technological advance. Doing something old in a new, cheaper way is one way to create a profit without really growing. A genuine profit is created because you are simply using less money to do the same thing but you need not raise the price! Another method might be a decrease in the price of oil since it’s such a huge economic driver (which we may see soon, especially with the help of China’s recent elimination of internal price fixing). Another possibility is a reduction in the lifestyle of Americas which would mean less spending on luxuries which frees up money for essentials thus driving the cost of luxuries down and the money spent on producing luxuries drops and that causes a disruption to the balance just enough to kick start the growth again. (Seems like an unlikely scenario, though.)
Hopefully this isn’t too inaccurate. As written, it passes my “gut” test which means it feels somewhat right, anyway. I’m sure someone will tell me what I’ve got wrong eventually, though.