Money & Interest Rates if Essay

Total Length: 1330 words ( 4 double-spaced pages)

Total Sources: 3

Page 1 of 4

There are two other things to consider. The first is that Fed policy can be assumed to be built into the markets. Prices in liquid markets are based on the best possible public information. Therefore, if I know about the pending change in the interest rates, that is public knowledge and will already be priced into the market rates. Any speculation I may have about interest rate changes is probably based on less information than what the market is already using, therefore my prediction has a lower likelihood of success; in case it is merely gambling to speculate.

The other consideration is that while changes in the interest rates may not impact the decision to purchase, they may impact the timing of the purchase. A house bought in 2006 when prices and rates were high would have been a much worse investment than the same house purchased in 2009 when prices and rates were low. Conversely, if expectations today are that rates will begin to rise in the next year or two then a major purchase now would be prudent; waiting could see the cost of that purchase increase significantly. In any case, the rate may impact the timing of the purchase but not likely the decision to purchase, unless the purchase was strictly as an investment with no other criteria attached.

4. In the current economy, rates are at the zero bound. However, the Fed still has the same tools in its arsenal for influencing interest rates. The Fed can increase rates if it believes that inflationary pressure is mounting. It has not done so because there is no evidence of inflationary pressure. The Fed cannot lower rates at this point, but that does not mean that it no longer has this tool, it means that it has used this tool. The Fed can also make statements with respect to its views of the state of the economy. If those views have concerns about inflation embedded, the market could take that as a sign of impending rate increases.
Addressing the economy as a whole is more complicated. The Fed is not the sole actor responsible for the state of the economy, which is good because it has very limited tools to address the economy. Interest rates are its primary tool, and it has used that tool to its fullest. Maintaining those low rates will encourage spending and investment, which will in turn help to drive the economic recovery. However, it is clear that low rates alone will not address this problem.

There are two schools of thought with respect to stimulating the economy. One school of thought holds that lowering taxes will stimulate investment. This argument may hold somewhat, but the impact of tax decreases -- especially at the high end where most tax decreases such as the estate tax elimination take place -- will do little to stimulate the economy. Much of that money disappears into savings, offshore or into investments and the trouble with the economy is not a shortage of investment capital. The economic problems are rooted in middle class debt and high unemployment. Stimulus from the government would act as a temporary means of lowering employment and would put more money into the hands of the middle class, which historically has a very low savings rate. Stimulus comes at a cost, however, in debt that must eventually be repaid. If debt-based stimulus is a good investment is an issue for another paper, but for the purposes of stimulating the economy today it is the strongest and most direct method available, especially when combined with low interest rates.

Works Cited:

Woodruff, T. (no date). A borrower's guide to forecasting interest rates. MSN Moneycentral. Retrieved June 25, 2010 from http://moneycentral.msn.com/content/investing/realestate/p39219.asp

No author. (2007). What goes around. The Economist. Retrieved June 25, 2010 from http://www.uam.es/personal_pdi/economicas/jotero/apuntes/Noticias3/bc_pm_jun07.pdf.....

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