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Interest Rate Marcroeconomics

Interest Rate

Marcroeconomics

Interest Rates

There are a number of interest rates that affects the economy in a number ways. An interest rate is basically the cost of borrowing money. There is an interest rate that we as private citizens have as set by the United States Federal Reserve, the Fed (About.) There is also the discount rate, which is interest rate that commercial banks have to pay in order to borrow money from the Fed (Mueller.) Also there is the Federal funds rate, which is the interest rate that one commercial bank will charge another commercial bank to borrow money. The federal funds rate is usually one percent lower the discount rate. Recently there was a change in the interest rate; the Fed decided to lower the rate by .25 percent to 4.5 percent. The interest rate has an affect on imports, exports, loans, and spending just to name a few examples. Interest rates also have impacts on unemployment, businesses, demand for money, and even stock prices.

With the recent cut in the interest rate, the value of the dollar internationally will weaken. This has a major affect on imports and exports. With a weaker dollar, American goods overseas become cheaper for foreign consumers (About.) Therefore American goods will be consumed more and exports will increase which in turn higher aggregate spending on goods and services is produced in the U.S. (About.) But on the other hand, with a weaker dollar, foreign goods become more expensive to Americans and imports will decrease. An example in foreign goods becoming more expensive is the recent increase in gas prices.

Cutting the interest rate has weakened the value of the U.S. dollar. With a reduction to the interest rate, the foreign capital owners are less attracted to investment there money in the United States. For this reason the strength of the U.S. dollar worldwide declines. The price of U.S stocks internationally will decrease.

With the cut in the interest rate, the cost of borrowing money will decrease. With the decrease in the cost, citizens will be willing to borrow more money. The demand for money will increase, and as more money is spent, prices of good will rise. This is a way in which the interest rate can affect inflation. Inflation happens when the price of almost all goods and services increase.

With the discount rate, the Fed is attempting to control inflation (Mueller.) When there is an abundance of money the demand for good is great. The problem is there is little supply. This is what causes inflation (Mueller.) Therefore with the recent cut in the interest rates, the Fed is increasing the amount of money available for purchasing goods; the Fed is attempting to control inflation (Mueller.) Because of the success, central banks in foreign countries do the same thing for the same reason (Mueller.) In other words, by decreasing the discount rate, the Fed attempts to raise the supply of money by making it less expensive to obtain. (Mueller.)

When the Fed changes the discount rate, there is not an immediate impact on the stock market. Instead, by decreasing the discount rate, there is a single direct effect. It becomes less expensive for banks to borrow money from the Fed (Mueller.) A change in the discount rate also causes a ripple effect. The factors that influence both individuals and businesses are affected. (Mueller.) One indirect effect of a decreased discount rate is that commercial banks decrease the rates that they charge their customers to borrow money. Another indirect affect are in credit card and mortgage interest rates. These interest rates for individuals decrease. This is especially if they carry a variable interest rate. A variable interest rate is an interest rate that moves up and down based on the changes of an underlying interest rate index (Mueller.) This will increase the amount of money consumers can spend. This means that people will spend more discretionary money, which is the amount of income an individual has leftover for spending, investing or saving after taxes and personal necessities have been paid, which will affect businesses' top revenues and profits (Mueller.) Businesses are also indirectly affected by the decrease in the discount rate. This is possible because businesses run on the actions of individual consumers. Also, businesses are affected in a direct way as well. They, borrow money from banks to run, improve, and expand their availability. As the banks make borrowing even cheaper, companies might borrow more and more. The reasons this will happen is because businesses will pay a lower rate of interest on their loans. More business spending can speed up the growth of companies, resulting in increases in profit (Mueller.)

Also stock prices will begin to rise as a result of the lower interest rate. With the cheaper price of money, private citizens and businesses will have more money to invest and save. So as interest rates drop, more money is put into the stock market, which raises the prices of stocks domestically. At the same time, if interest rates were to increase, the stock market would see a decline in money invested, and a fall in the price of stocks.

The interest rate was lowered by Fed due to speculation that the economy is slowing down. The economy is only expected to grow at a rate of about 1.8 percent to 2.5 percent next year, which are lower then the 2.5 percent to the 2.75 percent as predicted back in June. The Fed lowered the interest rate in an effort to try help to keep the economy from suffering as they expect higher inflation (La Monica.) Also, the Fed expects the unemployment rate to fall between 4.8 percent and 4.9 percent in 2008, which is higher then the 4.75 percent estimated in June. They expect the rate to stay in the same range for 2009 and 2010 (La Monica.)

The interest rate has an affect on many things which affects the economy and make a difference in how things are done. The interest rate determines how the demand of money changes, how much inflation moves, and how strong or weak the value of a dollar is internationally. When the interest rate is lowered, the price of stocks domestically rise, but the prices of U.S. stocks fall internationally. There is also an inverse relationship with imports and exports. Lower interest rates increases exports but it also decreases imports. Economically, the Federal Reserve uses interest rates help the economy stay stable. Interest rates can help induce or reduce inflation. For example, a fall in interest rate will increase inflation. Overall the Fed uses the interest rate as a tool to help stabilize the economy.

Work Cited

“About the Fed.” www.frbsf.org. Federal Reserve Bank of San Francisco. November 2007. 25 Nov. 2007. <http://www.frbsf.org/publications/federalreserve/monetary/affect.html>

La Monica, Paul R. “Fed sees economy slowing in 2008” money.cnn.com. November 2007. 25 Nov. 2007. <http://money.cnn.com/2007/11/20/news/economy/fed_outlook_analysis/index.htm?postversion=2007112016>

Mueller, Jim. “How Interest Rates Affect the Stock Market.” www.investopedia.com. Forbes Magazine. September 2006. 25 Nov. 2007 <http://www.investopedia.com/articles/06/interestaffectsmarket.asp>

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