INCREASE IN INTEREST RATES WHEN WHY ~ forex trading jobs south africa
The curtain hasn’t dropped on the latest Greek drama and the Chinese stock markets have yet to reach rock bottom but this week seems to belong to the U.S. economy and the question of what Fed Chairman Janet Yellen has in store for American citizens. Yellen reminded the bond market Friday that at least one interest rate increase is still in planned for 2015.
WHAT DO RAISED INTEREST RATES REALLY MEAN?
The Federal Reserve Bank, or Fed for short, is the central bank of the United States. It is totally separate from the U.S. government and has tremendous power in the financial sectors. Despite the fact that the Fed only exerts control on U.S. financial policy, the ramifications of its actions are felt throughout the world.
This makes the job of the Fed a challenging one as the responsibility of the economic health of millions of people–from the factory employee to the CEO of a major corporation–falls under its jurisdiction.
The Federal Reserve Bank controls interest rates through the sale or purchase of government-backed securities. If the central bank believes that lowering interest rates is necessary, it will buy a large amount of government bonds. The influx of cash to the banking system from these purchases results in a decrease in interest rates.
If the Fed deems it is to the benefit of the economy to raise interest rates, it will choose to sell these securities, thereby removing cash from the Treasury’s coffers and putting it back into the free market. The Fed can also decide to step in to adjust the federal funds rate, which is the rate for short-term loans between one bank and another and it can regulate the discount rate, which is the interest rate it charges banks for loans obtained directly from the Federal Reserve.
So what does all this mean for the average consumer? If you’re in the market for a car loan, for example, and read about the Fed reducing interest rates, you would expect to go to the bank and pay a lower rate than you would have done the week before. But this usually doesn’t happen. The interest rate you pay on a car loan is considered a ‘real interest rate’ which is the difference between the nominal interest rate set by the Fed and the inflation rate and this calculation doesn’t transmit to the consumer right away.
HOW AND WHEN DO CONSUMERS FEEL THE EFFECTS OF RAISED RATES?
The whole process is long and complicated but it works something like this: The Fed decides that it needs to raise interest rates because it needs to stimulate a sluggish economy and curb inflation.
We are all familiar with the concept of inflation. Basically it takes place when a form of currency starts to have less value over a period of time. This means that what was once bought for a certain amount of money, say $5.00, now costs $5.20 and so the original $5 falls short and is not enough anymore to purchase the same item.
Inflation is caused by several factors but it is usually attributed to the economic concept of supply and demand. When demand is great and supply is insufficient, the price of the item or service goes up.
Getting back to interest rates. If the Fed, looking at all relevant factors, decides that inflation will increase sometime in the future, it will set the real interest rate higher. However, if it sees that the cost of living is low, businesses are doing well and spending is brisk, it will keep interest rates down in order not to intervene in economic stimulation.
At the same time, the low interest rates will act to weaken the dollar which in turn makes foreign goods dearer and encourages consumers to buy made-in-America goods, increasing employment and workers’ wages. More money in the pocket further encourages spending and the economy blossoms.
The downside of this scenario is that with all this money moving around, demand starts to exceed supply, the price of the goods increases, and then demand for it starts to diminish. Reduced demand leads to less production, and eventually, unemployment ensues. Inflation has reared its nasty head.
This is where the Fed comes in. As I mentioned above, one of the Fed’s main responsibilities is to curb inflation and one of the ways it does that is to raise interest rates. This increase can strengthen the dollar and attract foreign investors looking for high-yield returns on their investments. The result is more demand for the dollar which enhances its value and will eventually slow down foreign investment.
This can be a double edged sword, however. A strong dollar is good for Americans purchasing foreign products and for those investing in foreign companies. But it creates competition with American companies and if these companies cannot keep up, they close down, causing unemployment and creating instability in the U.S. economy.
It is the obligation to maintain the balance between high and low interest rates that creates the most challenges for the Fed and its current chancellor, Janet Yellen, who runs the organization with a strong fist. The world gets smaller every day and the U.S. does not operate in a vacuum. What happens anywhere in the world has a direct effect on the American economy and plans that are ready to be put in action can be turned upside down in a matter of minutes.
Yellen was poised to raise interest several times this past year but as it turned out, it was never the right time to implement the change. The American economy has been bouncing around and seems to be on the mend from its last crash. But the Greece crisis has put the future of the euro in doubt and this has Washington pondering about its effect on the US dollar.
Add to this mix the recent crashes in the two main stock markets in China, one of America’s largest trade partners at the moment, and the question of an interest rate hike remains up in the air. Reports following the recent meeting of the Federal Reserve Wednesday, however, point to a strong U.S. economy, putting the possibility of an interest rate hike for this year back on the books. This will ultimately happen and will be the first such increase in nearly a decade.
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