What Is the Automated Clearing House (ACH)?

The Automated Clearing House (ACH) is an electronic funds-transfer system run by Nacha. The Automated Clearing House traces its roots back to the late 1960s but was officially established in the mid-1970s. The payment system provides many types of ACH transactions, such as payroll deposits. It requires a debit or credit from the originator and a credit or debit on the recipient’s end.

How the Automated Clearing House (ACH) Works

The ACH Network is an electronic system that serves financial institutions to facilitate financial transactions in the U.S. It represents more than 10,000 financial institutions and ACH transactions totaled more than $72.6 trillion in 2021 by enabling over 29 billion electronic financial transactions.

The network essentially acts as a financial hub and helps people and organizations move money from one bank account to another. ACH transactions consist of deposits and payments, including:

Here’s how the system works. An originator starts a direct deposit or direct payment transaction using the ACH network via debit and credit. The originator’s bank, also known as the originating depository financial institution, takes the ACH transaction and batches it together with other ACH transactions to be sent out at regular times throughout the day.

An ACH operator, either the Federal Reserve or a clearinghouse, receives the batch of ACH transactions from the originating institution with the originator’s transaction. The ACH operator sorts the batch and makes transactions available to the bank or financial institution of the intended recipient, also known as the receiving depository financial institution. The recipient’s bank account receives the transaction, thus reconciling both accounts and ending the process.

Special Considerations

The ACH payment system is offered by Nacha. Formerly known as the National Automated Clearing House Association, it’s a self-regulating institution. The ACH network’s history dates back to 1968 but wasn’t officially established until 1974.

This network manages, develops, and administers the rules surrounding electronic payments. The organization’s operating rules are designed to facilitate growth in the size and scope of electronic payments within the network.

Advantages and Disadvantages of the ACH

Advantages

Because the ACH Network batches financial transactions together and processes them at specific intervals throughout the day, it makes online transactions extremely fast and easy. NACHA rules state that the average ACH debit transaction settles within one business day, and the average ACH credit transaction settles within one to two business days.

The use of the ACH network to facilitate electronic transfers of money has also increased the efficiency and timeliness of government and business transactions. More recently, ACH transfers have made it easier and cheaper for individuals to send money to each other directly from their bank accounts by direct deposit transfer or e-check.

ACH for individual banking services typically took two or three business days for monies to clear, but starting in 2016, NACHA rolled out in three phases for same-day ACH settlement. Phase 3, which launched in March 2018, requires RDFIs to make same-day ACH credit and debit transactions available to the receiver for withdrawal no later than 5 p.m. in the RDFI’s local time on the settlement date of the transaction, subject to the right of return under NACHA rules.

Disadvantages

Certain financial institutions may restrict the amount of money you can transfer. If you want to do a large transfer, you may have to do this in multiple steps. For instance, if you’re transferring money to your child who’s away in college, you may be limited to transfers of $1,000. If they need more for books and rent, you will be required to send more than one transfer.

Some banks charge fees for ACH transactions. And this can be a per-transaction fee. If you’re used to doing multiple transactions, this can add up and put a big dent in your bottom line.

The ACH network only works between U.S. accounts. This means that you can’t conduct any transactions that are meant for international transfers using this payment system. So if you want to send money to someone abroad, you must do so using a wire transfer or other similar payment processing network. As such, the transaction will not necessarily be executed on the same day.

The Bottom Line

Sending money to someone else used to be a big hassle. But the advent of electronic technology is making things much easier. The Automated Clearing House or ACH facilitates transfers between banks. This eliminates the need for withdrawing money from one account and depositing it into another. The network is updated to allow businesses and individuals to execute transactions on the same day. But keep in mind that there are restrictions—notably, that you can’t send money internationally. You may also be limited in how much you can transfer and you may end up incurring fees. Check with your bank about how it handles ACH transactions.

What Is Aggregate Demand?

Aggregate demand is a measurement of the total amount of demand for all finished goods and services produced in an economy. Aggregate demand is commonly expressed as the total amount of money exchanged for those goods and services at a specific price level and point in time.

Understanding Aggregate Demand

Aggregate demand is a macroeconomic term and can be compared with the gross domestic product (GDP). GDP represents the total amount of goods and services produced in an economy while aggregate demand is the demand or desire for those goods. Aggregate demand and GDP commonly increase or decrease together.

Aggregate demand equals GDP only in the long run after adjusting for the price level. Short-run aggregate demand measures total output for a single nominal price level without adjusting for inflation. Other variations in calculations can occur depending on the methodologies used and the various components.

Aggregate demand consists of all consumer goods, capital goods, exports, imports, and government spending programs. All variables are considered equal if they trade at the same market value.

Aggregate Demand Components

Aggregate demand is determined by the overall collective spending on products and services by all economic sectors on the procurement of goods and services by four components:

Consumption Spending

Consumer spending represents the demand by individuals and households within the economy. While there are several factors in determining consumer demand, the most important is consumer incomes and the level of taxation.

Investment Spending

Investment spending represents businesses’ investment to support current output and increase production capability. It may include spending on new capital assets such as equipment, facilities, and raw materials.

Government Spending

Government spending represents the demand produced by government programs, such as infrastructure spending and public goods. This does not include services such as Medicare or social security, because these programs simply transfer demand from one group to another.

Net Exports

Net exports represent the demand for foreign goods, as well as the foreign demand for domestic goods. It is calculated by subtracting the total value of a country’s exports from the total value of all imports.

Aggregate Demand Formula

The equation for aggregate demand adds the amount of consumer spending, investment spending, government spending, and the net of exports and imports. The formula is shown as follows:

$\begin{aligned} &\text{Aggregate Demand} = \text{C} + \text{I} + \text{G} + \text{Nx} \\ &\textbf{where:}\\ &\text{C} = \text{Consumer spending on goods and services} \\ &\text{I} = \text{Private investment and corporate spending on} \\ &\text{non-final capital goods (factories, equipment, etc.)} \\ &\text{G} = \text{Government spending on public goods and social} \\ &\text{services (infrastructure, Medicare, etc.)} \\ &\text{Nx} = \text{Net exports (exports minus imports)} \\ \end{aligned}$​Aggregate Demand=C+I+G+Nxwhere:C=Consumer spending on goods and servicesI=Private investment and corporate spending onnon-final capital goods (factories, equipment, etc.)G=Government spending on public goods and socialservices (infrastructure, Medicare, etc.)Nx=Net exports (exports minus imports)​

The aggregate demand formula above is also used by the Bureau of Economic Analysis to measure GDP in the U.S.

What Affects Aggregate Demand?

Interest Rates

Interest rates affect decisions made by consumers and businesses. Lower interest rates will lower the borrowing costs for big-ticket items such as appliances, vehicles, and homes and companies will be able to borrow at lower rates, often leading to capital spending increases. Higher interest rates increase the cost of borrowing for consumers and companies and spending tends to decline or grow at a slower pace.

Income and Wealth

As household wealth increases, aggregate demand typically increases. Conversely, a decline in wealth usually leads to lower aggregate demand. When consumers are feeling good about the economy, they tend to spend more and save less.

Inflation Expectations

Consumers who anticipate that inflation will increase or prices will rise tend to make immediate purchases leading to rises in aggregate demand. But if consumers believe prices will fall in the future, aggregate demand typically falls.

Currency Exchange Rates

When the value of the U.S. dollar falls, foreign goods will become more expensive. Meanwhile, goods manufactured in the U.S. will become cheaper for foreign markets. Aggregate demand will, therefore, increase. When the value of the dollar increases, foreign goods are cheaper and U.S. goods become more expensive to foreign markets, and aggregate demand decreases.

Economic Conditions and Aggregate Demand

Economic conditions can impact aggregate demand whether those conditions originated domestically or internationally. The financial crisis of 2007-08, sparked by massive amounts of mortgage loan defaults, and the ensuing Great Recession, offer a good example of a decline in aggregate demand due to economic conditions.

With businesses suffering from less access to capital and fewer sales, they began to lay off workers and GDP growth contracted in 2008 and 2009, resulting in a total production contraction in the economy during that period. A poor-performing economy and rising unemployment led to a decline in personal consumption or consumer spending. Personal savings also surged as consumers held onto cash due to an uncertain future and instability in the banking system.

In 2020, the COVID-19 pandemic caused reductions in both aggregate supply or production, and aggregate demand or spending. Social distancing measures and concerns about the spread of the virus caused a significant decrease in consumer spending, particularly in services as many businesses closed. These dynamics lowered aggregate demand in the economy. As aggregate demand fell, businesses either laid off part of their workforces or otherwise slowed production as employees contracted COVID-19 at high rates.

Aggregate Demand vs. Aggregate Supply

In times of economic crises, economists often debate as to whether aggregate demand slowed, leading to lower growth, or GDP contracted, leading to less aggregate demand. Whether demand leads to growth or vice versa is economists’ version of the age-old question of what came first—the chicken or the egg.

Boosting aggregate demand also boosts the size of the economy regarding measured GDP. However, this does not prove that an increase in aggregate demand creates economic growth. Since GDP and aggregate demand share the same calculation, it only indicates that they increase concurrently. The equation does not show which is the cause and which is the effect.

Early economic theories hypothesized that production is the source of demand. The 18th-century French classical liberal economist Jean-Baptiste Say stated that consumption is limited to productive capacity and that social demands are essentially limitless, a theory referred to as Say’s Law of Markets.

Say’s law, the basis of supply-side economics, ruled until the 1930s and the advent of the theories of British economist John Maynard Keynes. By arguing that demand drives supply, Keynes placed total demand in the driver’s seat. Keynesian macroeconomists have since believed that stimulating aggregate demand will increase real future output and the total level of output in the economy is driven by the demand for goods and services and propelled by money spent on those goods and services.

Keynes considered unemployment to be a byproduct of insufficient aggregate demand because wage levels would not adjust downward fast enough to compensate for reduced spending. He believed the government could spend money and increase aggregate demand until idle economic resources, including laborers, were redeployed.

Other schools of thought, notably the Austrian School and real business cycle theorists stress consumption is only possible after production. This means an increase in output drives an increase in consumption, not the other way around. Any attempt to increase spending rather than sustainable production only causes maldistribution of wealth or higher prices, or both.

As a demand-side economist, Keynes further argued that individuals could end up damaging production by limiting current expenditures—by hoarding money, for example. Other economists argue that hoarding can impact prices but does not necessarily change capital accumulation, production, or future output. In other words, the effect of an individual’s saving money—more capital available for business—does not disappear on account of a lack of spending.

The Bottom Line

Aggregate demand is a concept of macroeconomics that represents the total demand within an economy for all kinds of goods and services at a certain price point. In the long term, aggregate demand is indistinguishable from GDP. However, aggregate demand is not a perfect metric and it is the subject of debate among economists.

What Is Annual Percentage Rate (APR)?

Annual percentage rate (APR) refers to the yearly interest generated by a sum that’s charged to borrowers or paid to investors. APR is expressed as a percentage that represents the actual yearly cost of funds over the term of a loan or income earned on an investment. This includes any fees or additional costs associated with the transaction but does not take compounding into account. The APR provides consumers with a bottom-line number they can compare among lenders, credit cards, or investment products.

How the Annual Percentage Rate (APR) Works

An annual percentage rate is expressed as an interest rate. It calculates what percentage of the principal you’ll pay each year by taking things such as monthly payments and fees into account. APR is also the annual rate of interest paid on investments without accounting for the compounding of interest within that year.

The Truth in Lending Act (TILA) of 1968 mandates that lenders disclose the APR they charge to borrowers. Credit card companies are allowed to advertise interest rates on a monthly basis, but they must clearly report the APR to customers before they sign an agreement.

How Is APR Calculated?

APR is calculated by multiplying the periodic interest rate by the number of periods in a year in which it was applied. It does not indicate how many times the rate is actually applied to the balance.

$\begin{aligned} &\text{APR} = \left ( \left ( \frac{ \frac{ \text{Fees} + \text{Interest} }{ \text {Principal} } }{ n } \right ) \times 365 \right ) \times 100 \\ &\textbf{where:} \\ &\text{Interest} = \text{Total interest paid over life of the loan} \\ &\text{Principal} = \text{Loan amount} \\ &n = \text{Number of days in loan term} \\ \end{aligned}$​APR=((nPrincipalFees+Interest​​)×365)×100where:Interest=Total interest paid over life of the loanPrincipal=Loan amountn=Number of days in loan term​

Types of APRs

Credit card APRs vary based on the type of charge. The credit card issuer may charge one APR for purchases, another for cash advances, and yet another for balance transfers from another card. Issuers also charge high-rate penalty APRs to customers for late payments or violating other terms of the cardholder agreement. There’s also the introductory APR—a low or 0% rate—with which many credit card companies try to entice new customers to sign up for a card.

Bank loans generally come with either fixed or variable APRs. A fixed APR loan has an interest rate that is guaranteed not to change during the life of the loan or credit facility. A variable APR loan has an interest rate that may change at any time.

The APR borrowers are charged also depends on their credit. The rates offered to those with excellent credit are significantly lower than those offered to those with bad credit.

APR vs. Annual Percentage Yield (APY)

Though an APR only accounts for simple interest, the annual percentage yield (APY) takes compound interest into account. As a result, a loan’s APY is higher than its APR. The higher the interest rate—and to a lesser extent, the smaller the compounding periods—the greater the difference between the APR and APY.

Imagine that a loan’s APR is 12%, and the loan compounds once a month. If an individual borrows $10,000, their interest for one month is 1% of the balance, or $100. That effectively increases the balance to $10,100. The following month, 1% interest is assessed on this amount, and the interest payment is $101, slightly higher than it was the previous month. If you carry that balance for the year, your effective interest rate becomes 12.68%. APY includes these small shifts in interest expenses due to compounding, while APR does not.

Here’s another way to look at it. Say you compare an investment that pays 5% per year with one that pays 5% monthly. For the first month, the APY equals 5%, the same as the APR. But for the second, the APY is 5.12%, reflecting the monthly compounding.

Given that an APR and a different APY can represent the same interest rate on a loan or financial product, lenders often emphasize the more flattering number, which is why the Truth in Savings Act of 1991 mandated both APR and APY disclosure in ads, contracts, and agreements. A bank will advertise a savings account’s APY in a large font and its corresponding APR in a smaller one, given that the former features a superficially larger number. The opposite happens when the bank acts as the lender and tries to convince its borrowers that it’s charging a low rate. A great resource for comparing both APR and APY rates on a mortgage is a mortgage calculator.

APR vs. APY Example

Let’s say that XYZ Corp. offers a credit card that levies interest of 0.06273% daily. Multiply that by 365, and that’s 22.9% per year, which is the advertised APR. Now, if you were to charge a different $1,000 item to your card every day and waited until the day after the due date (when the issuer started levying interest) to start making payments, you’d owe $1,000.6273 for each thing you bought.

To calculate the APY or effective annual interest rate—the more typical term for credit cards—add one (that represents the principal) and take that number to the power of the number of compounding periods in a year; subtract one from the result to get the percentage:

$\begin{aligned} &\text{APY} = (1 + \text{Periodic Rate} ) ^ n – 1 \\ &\textbf{where:} \\ &n = \text{Number of compounding periods per year} \\ \end{aligned}$​APY=(1+Periodic Rate)n−1where:n=Number of compounding periods per year​

In this case your APY or EAR would be 25.7%:

$\begin{aligned} &( ( 1 + .0006273 ) ^ {365} ) – 1 = .257 \\ \end{aligned}$​((1+.0006273)365)−1=.257​

If you only carry a balance on your credit card for one month’s period, you will be charged the equivalent yearly rate of 22.9%. However, if you carry that balance for the year, your effective interest rate becomes 25.7% as a result of compounding each day.

APR vs. Nominal Interest Rate vs. Daily Periodic Rate

An APR tends to be higher than a loan’s nominal interest rate. That’s because the nominal interest rate doesn’t account for any other expense accrued by the borrower. The nominal rate may be lower on your mortgage if you don’t account for closing costs, insurance, and origination fees. If you end up rolling these into your mortgage, your mortgage balance increases, as does your APR.

The daily periodic rate, on the other hand, is the interest charged on a loan’s balance on a daily basis—the APR divided by 365. Lenders and credit card providers are allowed to represent APR on a monthly basis, though, as long as the full 12-month APR is listed somewhere before the agreement is signed.

Disadvantages of Annual Percentage Rate (APR)

The APR isn’t always an accurate reflection of the total cost of borrowing. In fact, it may understate the actual cost of a loan. That’s because the calculations assume long-term repayment schedules. The costs and fees are spread too thin with APR calculations for loans that are repaid faster or have shorter repayment periods. For instance, the average annual impact of mortgage closing costs is much smaller when those costs are assumed to have been spread over 30 years instead of seven to 10 years.

APR also runs into some trouble with adjustable-rate mortgages (ARMs). Estimates always assume a constant rate of interest, and even though APR takes rate caps into consideration, the final number is still based on fixed rates. Because the interest rate on an ARM will change when the fixed-rate period is over, APR estimates can severely understate the actual borrowing costs if mortgage rates rise in the future.

Mortgage APRs may or may not include other charges, such as appraisals, titles, credit reports, applications, life insurance, attorneys and notaries, and document preparation. There are other fees that are deliberately excluded, including late fees and other one-time fees.

All this may make it difficult to compare similar products because the fees included or excluded differ from institution to institution. In order to accurately compare multiple offers, a potential borrower must determine which of these fees are included and, to be thorough, calculate APR using the nominal interest rate and other cost information.

The Bottom Line

The APR is the basic theoretical cost or benefit of money loaned or borrowed. By calculating only the simple interest without periodic compounding, the APR gives borrowers and lenders a snapshot of how much interest they are earning or paying within a certain period of time. If someone is borrowing money, such as by using a credit card or applying for a mortgage, the APR can be misleading because it only presents the base number of what they are paying without taking time into the equation. Conversely, if someone is looking at the APR on a savings account, it doesn’t illustrate the full impact of interest earned over time.

APRs are often a selling point for different financial instruments, such as mortgages or credit cards. When choosing a tool with an APR, be careful to also take into account the APY because it will prove a more accurate number for what you will pay or earn over time. Though the formula for your APR may stay the same, different financial institutions will include different fees in the principal balance. Be aware of what is included in your APR when signing any agreement.

What Is the Annual Percentage Yield (APY)?

The annual percentage yield (APY) is the real rate of return earned on an investment, taking into account the effect of compounding interest. Unlike simple interest, compounding interest is calculated periodically and the amount is immediately added to the balance. With each period going forward, the account balance gets a little bigger, so the interest paid on the balance gets bigger as well.

Formula and Calculation of APY

APY standardizes the rate of return. It does this by stating the real percentage of growth that will be earned in compound interest assuming that the money is deposited for one year. The formula for calculating APY is:

Where:

• r = period rate 
• n = number of compounding periods

What Annual APY Can Tell You

Any investment is ultimately judged by its rate of return, whether it’s a certificate of deposit (CD), a share of stock, or a government bond. The rate of return is simply the percentage of growth in an investment over a specific period of time, usually one year. But rates of return can be difficult to compare across different investments if they have different compounding periods. One may compound daily, while another compounds quarterly or biannually.

Comparing rates of return by simply stating the percentage value of each over one year gives an inaccurate result, as it ignores the effects of compounding interest. It is critical to know how often that compounding occurs, since the more often a deposit compounds, the faster the investment grows. This is due to the fact that every time it compounds the interest earned over that period is added to the principal balance and future interest payments are calculated on that larger principal amount.

Comparing the APY on 2 Investments

Suppose you are considering whether to invest in a one-year zero-coupon bond that pays 6% upon maturity or a high-yield money market account that pays 0.5% per month with monthly compounding.

At first glance, the yields appear equal because 12 months multiplied by 0.5% equals 6%. However, when the effects of compounding are included by calculating the APY, the money market investment actually yields (1 + .005)^12 – 1 = 0.06168 = 6.17%.

APY vs. APR

APY is similar to the annual percentage rate (APR) used for loans. The APR reflects the effective percentage that the borrower will pay over a year in interest and fees for the loan. APY and APR are both standardized measures of interest rates expressed as an annualized percentage rate.

However, APY takes into account compound interest while APR does not. Furthermore, the equation for APY does not incorporate account fees, only compounding periods. That’s an important consideration for an investor, who must consider any fees that will be subtracted from an investment’s overall return.

Example of APY

If you deposited $100 for one year at 5% interest and your deposit was compounded quarterly, at the end of the year you would have $105.09. If you had been paid simple interest, you would have had $105.

The APY would be (1 + .05/4) * 4 – 1 = .05095 = 5.095%.

It pays 5% a year interest compounded quarterly, and that adds up to 5.095%. That’s not too dramatic. However, if you left that $100 for four years and it was being compounded quarterly then the amount your initial deposit would have grown to $121.99. Without compounding it would have been $120.

X = D(1 + r/n)n*y

= $100(1 + .05/4)4*4

= $100(1.21989)

= $121.99

where:

• X = Final amount
• D = Initial Deposit
• r = period rate 
• n = number of compounding periods per year
• y = number of years

Special Considerations

Compound Interest

The premise of APY is rooted in the concept of compounding or compound interest. Compound interest is the financial mechanism that allows investment returns to earn returns of their own.

Imagine investing $1,000 at 6% compounded monthly. At the start of your investment, you have $1,000.

After one month, your investment will have earned one month worth of interest at 6%. Your investment will now be worth $1,005 ($1,000 * (1 + .06/12)). At this point, we have not yet seen compounding interest.

After the second month, your investment will have earned a second month of interest at 6%. However, this interest is earned on both your initial investment as well as your $5 interest earned last month. Therefore, your return this month will be greater than last month because your investment basis will be higher. Your investment will now be worth $1,010.03 ($1,005 * (1 + .06/12)). Notice that the interest earned this second month is $5.03, different from the $5.00 from last month.

After the third month, your investment will earn interest on the $1,000, the $5.00 earned from the first month, and the $5.03 earned from the second month. This demonstrates the concept of compound interest: the monthly amount earned will continually increase as long as the APY doesn’t decrease and the investment principal is not reduced.

Variable APY vs. Fixed APY

Savings or checking accounts may have either a variable APY or fixed APY. A variable APY is one that fluctuates and changes with macroeconomic conditions, while a fixed APY does not change (or changes much less frequently). One type of APY isn’t necessarily better than the other. While locking into a fixed APY sounds appealing, consider periods when the Federal Reserve is raising rates and APYs increase each month.

Most checking, savings, and money market accounts have variable APYs, though some promotional bank accounts or bank account bonuses may have a higher fixed APY up to a specific level of deposits. For example. a bank may reward 5% APY on the first $500 deposited, then pay 1% APY on all other deposits.

APY and Risk

In general, investors are usually awarded higher yields when they take on greater risk or agree to make sacrifices. The same can be said regarding the APY of checking, saving, and certificate of deposits.

When a consumer holds money in a checking account, the consumer is asking to have their money on demand to pay for expenses. At a given notice, the consumer may need to pull out their debit card, buy groceries, and draw down their checking account. For this reason, checking accounts often have the lowest APY because there is no risk or sacrifice for the consumer.

When a consumer holds money in a savings account, the consumer may not have immediate need. The consumer may need to transfer funds to their checking account before it can be used. Alternatively, you cannot write checks from normal savings accounts. For this reason, savings accounts usually have higher APYs than checking accounts because consumers face greater limits with savings accounts.

Last, when consumers hold a certificate of deposit, the consumer is agreeing to sacrifice liquidity and access to funds in return for a higher APY. The consumer can’t use or spend the money in a CD (or they can after paying a penalty to break the CD). For this reason, the APY on a CD is highest of three as the consumer is being rewarded for sacrificing immediate access to their funds.

The Bottom Line

APY in banking is the actual rate of return you will earn on your checking or savings account. As opposed to simple interest calculations, APY considers the compounding effect of prior interest earned generating future returns. For this reason, APY will often be higher than simple interest, especially if the account compounds often.