March 11, 2009
The Federal Reserve is the Central Bank of the United States and it aids in directing the economy and ensures high rate of employment, stability in prices with reasonable interest rates and sustenance in economic growth.
Let’s begin with Interest rates- the main objective of the Federal Reserve are the interest rates. They influence the Fed in controlling the flow of money in the economy. The Fed s often uses the federal funds rate as the level of interest rate. The bank uses the rate of federal funds as the interest rate when they loan over nightly with each other. Interest rate helps in controlling the economy which is one tool of Federal Reserve monetary policy. For example if the Fed observes rise in flow of money in the economy then they raise the interest rate to reduce lending and borrowing which results in reduction of credit available. Or if they observe vice versa they will reduce the interest rate to make credit available and increase consumers buying services and products.
In the Credit crisis of 2007, the interest rate shot up creating fear in banks loaning with each other. Due to which the Fed eventually had to lower the rate to calm their fears and boost the financial markets. The rate was reduced to 4.75% in Sept 07which then had to be lowered to 3% in Jan 08. This still didn’t regain confidence of the banks or secure credit flow. Again the failure of Lehman Brothers, Bear Stearns and AIG gave rise to the use of TARP program in order to provide funds to big financial institutions that were in danger of failing too. By Oct 08 the interest rate was as low as 1% and at present is shuttling between 0 to 0.25 %. This has had an effect on the economy. Even though the interest rate is as low as 1%, credit still does not flow smoothly in the US economy. The Prime interest rate is the best rate that can be given to non banks or credit worthy borrowers with limited credit. This shows us that even despite of having such low interest rates, there still lies the unavailability of credit. Therefore, it shows that the U.S. Monetary policy is not helping in the times of the recession to stimulate the economy.
Connection:
Everybody needs money to run their business. They depend on each other to borrow money. Banks could be the best example to choose. Canada Trust (TD) borrows money from other banks when needed and the Bank of Canada. Likewise, US banks borrow money from other banks and the Central Bank of United States. Interest rates changes all the time. When the interest rates increases, borrowing money from others will increase as well, Cost of goods sold would increase and the gross profit for one will decrease because then one would have to pay off his debts(money borrowed from others) with the interest rate. In this case, the interest rates are going down from 4.75% to 3% to 1% to 0.25% which is not beneficial for the economy but good for the business owners, the ones who took loans for their houses and car because then the money that they have borrowed from other would have less interest rates. Cost of Goods Sold would decrease and the Gross Profit will increase which is really beneficial for any of the business owner.
Reflection:
Downfall of the economy is not beneficial for any of the consumer or anyone who works for someone because then he will always be scared of loosing his job. Downfall of economy affects everyone except for some of the business owners (the ones who fulfill the basic needs for every household and family). I remember when the economy was really down in Canada especially after the Olympics. A lot of people lost their jobs and had hard time running their family. Some of the people decided to go for EI (employement insurance) that is the government will provide money for them. Think about it if everyone decides to go for EI, Government will eventually run of money which is not good for the country. So its really not beneficial for the economy to go down.
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