Why would the PRIME RATE of grow over time?

Question

the fed dropped the prime rate 1/2 point to 7.75 today. It has seen temporary peaks as high as 21 percent in 1980. It was as low as 4 percent in 2003. However, in 1947 it was 1.75 percent and through the 50's was 2-3 percent. Overall, the direction has been up. Why would we not see 1.75 percent again?

Southron, you assume lower is better. Interest was taxable in 1947. Eliminating tax on interest would increase other taxes--unless your plan is part of the ultra-right-wing conspiracy. Which I think it is.

Meg this sounds like conventional economics wisdom--but why should banks want to loan more money when interest rates are low? Is it really a fact the government "lends money to the banks" at the prime rate--but instead only sets the rate? But don't let me mess up your grades (if you are a student).

Answer 1

We won't see 1.75 again unless we see the amount of spending that took place in WWII. If you look at the historical trends, it was only 1.75 one time.

I could pick a different date range (1978 to 2001) and say it has gone DOWN over time. True?



Then again, in the end, we're just looking at nominal rates....not inflation adjusted rates.

Answer 2

The prime rate is only low when their is little or no inflation. It also drops during recessions when no one wants to borrow money to expand their businesses and everyone is holding money waiting for better times. If both occur at the same time it is very low. The high point in 1980 was during a period of very high inflation and as inflation declined to around 2 or 3 % the prime has followed it down. The fed policy is to keep the inflation from falling to zero or negative since the 1950's so we will probably not see such low rates again.

EDIT: The fed funds rate is the overnight rate between banks that the fed controls by adding to or subtracting from the funds available for loans. If you goto http://www.economagic.com/fedbog.htm
you can plot both the prime rate and the fed funds rate from 1949 to the present and add shaded areas for recessions. Most of the time the prime rate is higher, but when the fed is fighting inflation the fed rate is equal or greater the the prime..

Banks will loan money as long as they have a source of funds at a lower interest rate than they can collect from borrowers. If they think rates will rise due to greater demand in the future they will charge more interest for long term loans. The difference between the long and short rates is a good predictor on the economy next year..

Answer 3

We could and should
see how:
http://www.fairtax.org/PDF/TheImpactOfTheFairTaxOnInterestRates.pdf