Interest Rates

Résumé du document

It is a well known that interest rates have a commensurable power to influence the economy as a vital tool of monetary policy that is used to control variables like investment, inflation, price stability and unemployment. Generally speaking, the interest rate is described as the cost of using money. We will try to understand what the interest rate precisely is and what determines the prime rate. Then, we will focus on the means to influence the levels in a given an economic situation by the Fed. Finally, we will prove these different possible variations with the help of historical examples. The interest rate is the price that is usually expressed in percentage over a period of time. In simple terms, it is the price that someone pays for the temporary use of someone else's funds (Federal Reserve Bank of New York, 2002). In a way, Interest is the compensation that someone receives for temporarily giving up the ability to spend money or the use of money for a period of time. Let's clarify it with the equation of the simple interest rate (calculated on the original price).

Extraits

[...] This is principally important for the consumer who will have his loans and credit card rates getting more and more expensive. References Interest Rates: An introduction. (2002, June 17). Federal Reserve System Publication Catalogue. Retrieved February from http://www.ny.frb.org/publications/frame2.cfm?url=%2Feducation%2Fintere st%5Frates%2Ehtml. Ben S. Bernanke (2006, February 15). Testimony of Chairman Ben S. Bernanke. The Federal Reserve Boards. [...]

[...] Interest Rates Generally speaking the interest rate is described as the cost of using money. It is also well known that interest rates have a commensurable power to influence the economy as a vital tool of monetary policy that is used to control variables like investment, inflation, price stability and unemployment. We will in a first time try to understand what is precisely the interest rate and what determine the prime rate. Then, we will focus on the means to influence is level given an economic situation by the Fed. [...]

[...] Increase (decrease) of the Federal Fund rate ( Increase (decrease) of the prime rate Those variations of the interest rate play on the investment rate, the consumption, the saving rate, the money supply (that is, the inflation). Effectively, a high interest rate reduces the consumer consumption and increases his saving by reducing the proportion for investment. If interest rates are higher it costs more money to borrow money, that is to invest your money (by the means of loan for example that are becoming more expensive). Then, you reduce the part allowed to investment and consumption and increase your saving. As we also say, a high interest rate reduces the money supply that is the inflation. [...]

[...] Those moves are due to the Fed's decisions. Effectively, The Fed (The Federal Reserve System is the central bank of the United States which main objective is the controle of the money supply) is the authority that manipulates the interest rate for the United- States. They use three tools to achieve their objective to control the money supply (which induce some variations in the interest rate): 1. Discount rate - It is the rate the FED lend to commercial bank 2. [...]

[...] Both the FFR and the discount rate level (decided by the Fed) set variations on the Prime Rate. A higher (smaller) FFR and discount rate increase (decrease) the Prime Rate. The consequences are a reduction of the consumption and the inflation. It has been proved historically that this increase (decrease) is made during expansion (recession) period to contract (stimulate) the economy. Nowadays, The Fed is increasing the FFR (rate is since March 27, 2006) considering that the economy has to be slow down. [...]