Could somebody explain to me why it is so significant if the fed or central bank lowers interest rates or not?

Question

Is this news overhyped? I have yet to really understand why everybody anxiously waits on this news so much . They talk about it like it is opening up a water faucet or something to allow more money in the economy or not? I understand it may give loaner banks a little more incentive or not to loan money , but seriously do you think it is really that big of a indicator as to where the economy is going to head?

Also where does the money go that is already in the economy? Does it just evaporate or something? Why do we always have to depend on more and more money being printed up?

Answer 1

When the Fed changes the interest rate, they change the money supply. They accomplish this through open market operations. When they want to raise the interest rate, they sell bonds to banks, accomplishing this by reducing the amount of reserves that the bank holds with the Fed. When they want to lower the interest rate, they do the opposite. By doing this to the reserves, they have a larger impact on the amount of money in the money supply due to the money multiplier. Banks are required to keep a certain percentage of their deposits on reserve. The rest are allowed to be loaned out. Thus, the amount of currency in circulation is not the amount of money in the money supply. The money supply is larger because of this money multiplier. For example, let's say the reserve requirement is 10%.This would yield us a money multiplier of 1/reserve requirement, or 10. Thus, every $1,000 put into reserves increases the money supply by $10,000. So, by raising and lowering the interest rate, there is a large impact to the money supply.
More money being printed does not really have anything to do with the interest rate. The Federal Reserve determines the interest rate, but they do not print the money. The Treasury is responsible for that.
Other individuals are also interested in the interest rate because it is used by the Federal Reserve to keep inflation in check. Thus, if it is being raised, inflation is a concern, indicating that maybe the economy won't be as good going forward. For this reason, the interest rate is watched by the stock markets, since the stock market is based upon the underlying businesses in the economy and how they perform. Rising interest rates make it harder for these businesses to borrow and expand, which can have an impact on profits and thus the price of the stock itself.
Hope this helps.

Answer 2

For one money doesn't evaporate. If you haven't already noticed on the one dollar bills theres a letter. Each letter goes to a one of the branches of the federal bank. When they think that the bill can't be used anymore they print new ones. If you haven't notice our paper money is worthless unless we have something to back it up with. Take for example Fort Knox, theres millions of dollars worth of gold in that place. The reason that people watch the banks is that if our economy starts to inflate then our money will be less then what it is now. This is common among many countries. If you look at Hong Kong's economy, it's growing. The one difference between our economy and theres is, that our government steps in and we don't have the potential to grow. Those all the numbers of unemployed workers in America.

Answer 3

think of money as something that only has power when it's moving. Money is only worth what you can buy with it. Our government controls the flow of money by using interest rates. you indicated that you get that part, with incentives to save (high rates) versus incentives to spend (low rates). Money that is already in the economy doesn't evaporate so much, but if people choose not to spend it, then it doesn't move and it does not have power. In that way a higher interest rate will motivate people to save their money and effectively slow the flow of money, which will make it seem like some of it disappeared. A lower rate will encourage people to spend, and it will make it seem like there is more money because it will move more. Higher interest rates soak up excess money in the economy in order to combat inflation. If there is too much money moving around, prices will go up. Our government is interested in keeping our economy stable, and interest rates are the factors they manipulate in order to do so.

Answer 4

Mark's intuition is close; if interest rates are high, people's savings/consumption ratios change. There is a higher incentive to save money at higher rates, so consumption does indeed drop.

There is less of an incentive for businesses (and people) to borrow for investment; so investment drops.


If rates are lowered, it causes more of an incentive to borrow and less of an incentive to save, it increases spending and boosts GDP.

Note that this is strictly a short-term phenomenon.


Also; the Fed does not print money. The Fed controls interest rates by controlling the money supply; when they want to raise interest rates they sell bonds (for which they receive cash), when they want to lower rates they buy bonds (which puts more cash into circulation).

Answer 5

The higher the interst rates are, the less money people will borrow and therefore they will have less to spend. If people can't spend as much then prices stay low.

If the interest rates drop, then people have more money to spend (either by borrowing, or not paying high interest charges) and that allows vendors to charge more for their goods and services.

If people have too much money to spend this leads to inflation, if people don't have enough money to spend this leads to recession.

Answer 6

Keeping it simple...

Lowering the interest rate, means banks will loan money at a lower interest rate. A lower interest rate from the banks means credit card interest rates, home loans, student loans, car loans, etc. all cost less. This means people can and generally will buy more.

The problem then becomes, people buy too much, prices go up, and inflation occurs. So, the Fed. increases interest rates to try and keep inflation in check.

wax on, wax off

Answer 7

When the feds or central bank lowers interest rates, it means that it has lowered the cost at which Govt or the central bank borrows from the private sector financial institutions.

This therefore means that the private sector financial institutions and banks will become less predisposed towards lending to govt. in the form of bonds and treasury bills and notes. at the lower interest rate. Now because govt. thru the Feds or Central bank is usually the largest borrower of funds and it no longer requires so much from the banks/fiancial institutions, a lot more money is made available for the private sector businesses to borrow.

There is now a much larger pool of funds available to borrow from by the same group of businesses, thus a situation of greater supply with limited demand.

Thus the higher supply of funds drives down the cost of borrowing by the private sector, subsequently leading to lower interest rates and mortgage rates in the economy.

Conversely when govt. or the feds increase interest rates, lending to business becomes unattractive and most banks and financial institutions tend to lend more to govt. at the higher rate of return, in the form of treasury bills, notes and bonds.

There is therefore now, a smaller pool of funds available for businesses to borrow from and this phenomenon is what is described as 'CROWDING OUT'. (i.e. govt/feds/central bank is crowding out the economy). Private sector businesses therefore have to pay higher interest rates to attract the banks to lend to them, or as usually happens, the banks feel disposed to charging a higher interest on loans or mortgages.

The cost of production for businesses therefore goes high, mortgage rates go high, leading to higher prices and therefore there is reduced spending iby consumers in the economy. Another result is that in the process of reducing their cost of production, many businesses as a first step will decide to rationalise their staffing levels leading to retrenchments and lay-offs of workers thus increasing the rate of unemployment, with a whole series of effects following it that may not be discussed here.