The Fed and Interest RatesDave Pettit of The Wall Street Journal writes a daily column thatappears inside the first page of the journal’s Money ; Investmentsection. If the headlines of Mr. Pettit’s daily column are any accuraterecord of economic concerns and current issues in the business world,the late weeks of March and the early weeks of April in 1994 wereintensely concerned with interest rates. To quote, “Industrials Edge Up4.
32 Points Amid Caution on Interest Rates,” and “Industrials Track On13. 53 Points Despite Interest-Rate Concerns. ” Why such a concern withinterest rates? A week before, in the last week of March, the Fed hadpushed up the short-term rates. This being the first increase in almostfive years, it caused quite a stir. When the Fed decides the economy is growing at too quick a pace, orinflation is getting out of hand, it can take actions to slow spendingand decrease the money supply.Order now
This corresponding with the moneyequation MV = PY, by lowering both M and V, P and Y can stabilize ifthey are increasing too rapidly. The Fed does this by sellingsecurities on the open market. This, in turn, reduces bank’s reservesand forces the interest rate to rise so the banks can afford to makeloans. People seeing these rises in rates will tend to sell their lowinterest assets, in order to acquire additional money, they tend movetoward higher yielding accounts, also further increasing the rate. Soonthis small change by the Fed affects all aspects of business, from theprice level to interest rates on credit cards.
Rises and falls in the interest rate can reflect many changes in aneconomy. When the economy is in a recession and needs a type ofstimulus package, the Fed may attempt to decrease the interest rates toencourage growth and spending in the markets. This was the case from1989 until last month, during which the nation’s economy was generallyconsidered to be in a slight to moderate recession. During this periodthe Fed tried to keep interest rates low to facilitate growth andspending in hard times.
However, when inflation is increasing tooquickly and the economy is gaining strength, the Fed will attempt toraise rates, as it did late last March. This can be considered a signthat we are pulling out of the recession, or atleast it seems the Fedfeels the recession of the early nineties is ending. Directly after the Fed’s actions, the stock market was a mess. The Dowtook huge dips, falling as much as 50 points a day. Although no oneknows exactly what influences the market, the increase in interest ratesplayed a major role in this craziness. Mr.
Pettit’s column on March25th highlights, “Industrials Slide 48. 37,” Mr. Pettit attributes alarge portion of the market’s “tailspin” at this time to, “Risinginterest rates at home. ” It is certainly no coincidence that these twoevents happened at the same time.
Alan Greenspan, the current chairman of the Fed comes under greatattack and praise with every move the Fed makes. He is, in a sense, theembodiment of the Fed. He has been in charge of the Fed since 1987. Some economists blame him for the recession of the early nineties. Hisinfluence on the interest rates as chairman of the Fed is monumental. It is his combined job as the Fed to steer the economy in a balancedmanner that does not yield too much to inflation and to keep growthsteady.
Predictably, most economists are back seat drivers when itcomes to watching the actions of Allen Greenspan, and they tend to feelthey could much more successfully manage the economy than he. Many alsoagree with his tactics, so it is a two way street on which the chairmanis forced to drive. It seems that not only the analysts are in disagreement of how the fedshould operate, but interestingly enough, the internal policy makersseem to also disagree on what stance the Fed should take. Some of theinternal policy makers are interested in making a more substantialincrease now, while others opt for a more conservative approach, wherethe market can be tested for both good and bad influences from the rateincreases. Allen Greenspan is one of this more conservative group, andit is he is critisized by some for the irradic behavior in the stockmarket as of late. The equilibrium that the Fed is looking for occurs when an interestrate is set that makes the quantity of real money available be willinglyheld.
Because this is such a delicate system this “equilibrium” isnever exactly met, and the Fed’s job is to try to keep the market at ornear this form of equilibrium. Unfortunately this case is never exactlymet, 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 paysspecial attention on the issue of inflation, and how differentforecasters will interpret the Fed’s actions. Overall, this articlegives the reader a good understanding of what took place, and whatrepercussions 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 discussesthe fact that the Fed’s policy makers were somewhat split between thosewho were looking for a “slight” increase as opposed to one of “somewhatgreater” magnitude. This article is interesting because it shows thateven the Fed can be uncertain about what is best for the economy, but itstill focuses on the power of Allen Greenspan, as well as the committeeas a whole. It compares the two arguments of each method, and shows aweakness 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 theinterest rate, and complains that the Fed has fallen behind in it’sjob. It discusses the plan for a “Neutral” policy and what the Fed hastried to do and not do to maintain this so called policy. It argues themotives and reasons for wanting a lower interest rate and compares pastdecades to today’s standings. Overall it focuses deeply on the need tocheck inflation and if it is valid. It shows that the Fed tends to takea more conservative approach to the economy than some analysts wouldprefer, but that the Fed will probably continue to raise interest rates.————————————————————–