The interest rates may fluctuate at 11 am today, which means those of you who care about or use money should read this post. Over the past few weeks I have released many writings on the Fed’s economic reach and structure. Let’s rewind, to examine the process and meaning of an interest rate hike.
The government has two tools that it can use to try to influence the direction of the economy. Monetary policy created by the Federal Reserve Board and controls cash flow. Fiscal policy is controlled by the President and determines government spending and taxation.
The Federal Reserve Board may change the discount rate in an effort to guide the economy through the business cycle. Remember, the discount rate is the rate that the Fed charges member banks on loans. This rate is highly symbolic, but as the Fed changes the discount rate, all other interest rates change with it. If the Fed wanted to stimulate the economy, it would reduce the discount rate. As the discount rate falls, all other interest rates fall with it, making the cost of money lower.
As the discount rate increases all other rates go up with it, raising the cost of borrowing. As the cost of borrowing increases, demand and the economy slow down. In approximately an hour hours we will find out the health of our economy. If the Fed trust in our economy’s capabilities they will want to slow the economy down, which would increase the discount rate.