The Fed

"The Fed" refers to the Federal Reserve. The Federal Reserve's primary function is to keep the economic system in balance. The Federal Reserve has three economic controls to influence imbalances like high inflation rates, it can alter the amount of reserve that member banks are required to maintain; control the discount rate; and, the Federal Funds rate. (more on the Federal Reserve, and Federal Reserve Act of 1913).

The discount rate is the interest rate that member banks use to borrow money from the Federal Reserve. The federal rate is one that banks use to borrow from each other. If the economy is growing too fast, the Federal Reserve will raise the federal rate to hold back the inflationary trend.

Finally, there is also the "real" interest rate. The real interest rate is the average Federal Funds rate minus the inflation rate. Most economists use the real interest rate for analysis to determine the general future direction of interest rates and the overall market. These rates are also used to control the inflationary trend as well as the interest rate trend, and have a significant impact on investors. (Read about: interest rates)

The dynamics between inflation and interest rates have a direct effect on the stock market. When inflation moves too high the Fed raises interest rates, which makes credit more expensive, which reduces the amount of cash out in the market place which finally slows economic growth and thereby reduces inflation. But it also creates a down stock market when interest rates move too high. (Read about a little history on the effect inflation has had in the stock market's past)