Federal Reserve officials have recently announced that the federal funds rate will once again be increased. According to the Washington Post, this will be the 12th consecutive increase since 2004.
What does this mean for the average consumer? Don Schalagenhauf, professor of economics at Florida State University, explained what can happen when these type of rates go up.
“When these rates are increased, things like mortgage rates and credit card debt rates tend to increase as well,” Schalagenhauf said.
Schalagenhauf explained that federal fund rates, which are interest rates charged between banks for loans, have been rising recently due to concern about possible inflation.
Inflation occurs when there are not enough products to meet the demands of the consumer.
Nathaniel Johnson, professor of economics at Florida A&M University, said there are three main tools the Reserve uses to control monetary policy, which influence interest rates. Those are: open market operations, reserve requirement ratios and the discount rate.
Open market operations, as defined by the Reserve, are the purchases and sales of U.S. Treasury and federal agency securities. Securities are basically things such as treasury bonds, notes and bills.
Johnson said when the Reserve needs to raise interest rates, selling these securities is one method of reaching that goal.
When this is done, money is taken out of circulation and out of banks, causing interest rates to rise.
The reserve requirement ratio is the amount of money that depository institutions must have on reserve for deposit liabilities. The Reserve defines these liabilities as being the net transaction accounts, non-personal time deposits and euro-currency liabilities at a particular financial institution.
Johnson said that during times of high interest rates, the Reserve raises these ratio requirements, forcing banks to limit the amount of loans that they can give out.
Lastly, the discount rate is the rate that the Reserve charges member banks to borrow money from the government. Johnson said when these discounted rates are increased, banks also raise the amount of interest on loans offered to the public.
“With cost of living constantly increasing and household’s disposable income constantly decreasing, the Reserve is making it harder for the consumer,” said Nicole Stewart, a junior business student from Cleveland.
Johnson said that what the Reserve is attempting to do when interest rates are increased is to keep the public from spending too much money. The reason for this probably because of a growing concern over a shortage in money supply.
Professor Schalagenhauf provided a similar explanation. He said what the Reserve is trying to do is slow the growth of the economy. He also said that with the current rates, it is easier to conduct monetary policy.
“It’s hard to conduct monetary policy when interest rates are so low,” Schalagenhauf said.
In the press release following the decision to increase federal fund rates again, officials cited two main reasons as to why there was some trouble with the economy;
One reason was the rise in energy costs. The other reason was the recent hurricanes Wilma and Katrina. Officials said that the energy prices and hurricanes have slowed output and employment.
Professor Schalagenhauf said that if the new chairman of the Reserve thinks that output is moving too slow, he will probably lower interest rates in order to stimulate the economy, but he said that he doubts that will happen.
“I wouldn’t be surprised if the rates were raised a little more,” Schalagenhauf said.
“Right now, there is an uptrend in rates, and I don’t think they will be coming down soon,” Johnson said.
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