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The Fed And Interest Rates Essay Research

The Fed And Interest Rates Essay, Research Paper


The Fed and Interest Rates


Dave Pettit of The Wall Street Journal writes a daily column that


appears inside the first page of the journal’s Money & Investment


section. If the headlines of Mr. Pettit’s daily column are any accurate


record of economic concerns and current issues in the business world,


the late weeks of March and the early weeks of April in 1994 were


intensely concerned with interest rates. To quote, “Industrials Edge Up


4.32 Points Amid Caution on Interest Rates,” and “Industrials Track On


13.53 Points Despite Interest-Rate Concerns.” Why such a concern with


interest rates? A week before, in the last week of March, the Fed had


pushed up the short-term rates. This being the first increase in almost


five years, it caused quite a stir.


When the Fed decides the economy is growing at too quick a pace, or


inflation is getting out of hand, it can take actions to slow spending


and decrease the money supply. This corresponding with the money


equation MV = PY, by lowering both M and V, P and Y can stabilize if


they are increasing too rapidly. The Fed does this by selling


securities on the open market. This, in turn, reduces bank’s reserves


and forces the interest rate to rise so the banks can afford to make


loans. People seeing these rises in rates will tend to sell their low


interest assets, in order to acquire additional money, they tend move


toward higher yielding accounts, also further increasing the rate. Soon


this small change by the Fed affects all aspects of business, from the


price level to interest rates on credit cards.


Rises and falls in the interest rate can reflect many changes in an


economy. When the economy is in a recession and needs a type of


stimulus package, the Fed may attempt to decrease the interest rates to


encourage growth and spending in the markets. This was the case from


1989 until last month, during which the nation’s economy was generally


considered to be in a slight to moderate recession. During this period


the Fed tried to keep interest rates low to facilitate growth and


spending in hard times. However, when inflation is increasing too


quickly and the economy is gaining strength, the Fed will attempt to


raise rates, as it did late last March. This can be considered a sign


that we are pulling out of the recession, or atleast it seems the Fed


feels the recession of the early nineties is ending.


Directly after the Fed’s actions, the stock market was a mess. The Dow


took huge dips, falling as much as 50 points a day. Although no one


knows exactly what influences the market, the increase in interest rates


played a major role in this craziness. Mr. Pettit’s column on March


25th highlights, “Industrials Slide 48.37,” Mr. Pettit attributes a


large portion of the market’s “tailspin” at this time to, “Rising


interest rates at home.” It is certainly no coincidence that these two


events happened at the same time.


Alan Greenspan, the current chairman of the Fed comes under great


attack and praise with every move the Fed makes. He is, in a sense, the


embodiment of the Fed. He has been in charge of the Fed since 1987.


Some economists blame him for the recession of the early nineties. His


influence on the interest rates as chairman of the Fed is monumental.


It is his c

ombined job as the Fed to steer the economy in a balanced


manner that does not yield too much to inflation and to keep growth


steady. Predictably, most economists are back seat drivers when it


comes to watching the actions of Allen Greenspan, and they tend to feel


they could much more successfully manage the economy than he. Many also


agree with his tactics, so it is a two way street on which the chairman


is forced to drive.


It seems that not only the analysts are in disagreement of how the fed


should operate, but interestingly enough, the internal policy makers


seem to also disagree on what stance the Fed should take. Some of the


internal policy makers are interested in making a more substantial


increase now, while others opt for a more conservative approach, where


the market can be tested for both good and bad influences from the rate


increases. Allen Greenspan is one of this more conservative group, and


it is he is critisized by some for the irradic behavior in the stock


market as of late.


The equilibrium that the Fed is looking for occurs when an interest


rate is set that makes the quantity of real money available be willingly


held. Because this is such a delicate system this “equilibrium” is


never exactly met, and the Fed’s job is to try to keep the market at or


near this form of equilibrium. Unfortunately this case is never exactly


met, and the market can easily suffer because of it.


Summary of Articles:


US News (Late March 1994) -


“Interest Rates: The Fed Strikes Again”


This article covers a brief explanation of exactly what the Fed did,


covering the major factors and influences of the Fed’s actions. It pays


special attention on the issue of inflation, and how different


forecasters will interpret the Fed’s actions. Overall, this article


gives the reader a good understanding of what took place, and what


repercussions are likely to come about because of it.


The Wall Street Journal (Mon. March 28, 1994) -


“Fed Was Divided on Rate-Rise Size Voted in February”


This article shows an interesting perspective of the Fed. It discusses


the fact that the Fed’s policy makers were somewhat split between those


who were looking for a “slight” increase as opposed to one of “somewhat


greater” magnitude. This article is interesting because it shows that


even the Fed can be uncertain about what is best for the economy, but it


still focuses on the power of Allen Greenspan, as well as the committee


as a whole. It compares the two arguments of each method, and shows a


weakness in the Fed that may have been unknown to the reader before.


The Wall Street Journal (Mon. April 11, 1994) -


“Fed Moved Too Slow On Increasing Rates”


This recent article criticizes the Fed’s actions in raising the


interest rate, and complains that the Fed has fallen behind in it’s


job. It discusses the plan for a “Neutral” policy and what the Fed has


tried to do and not do to maintain this so called policy. It argues the


motives and reasons for wanting a lower interest rate and compares past


decades to today’s standings. Overall it focuses deeply on the need to


check inflation and if it is valid. It shows that the Fed tends to take


a more conservative approach to the economy than some analysts would


prefer, but that the Fed will probably continue to raise interest rates.

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