Increase In Rates By The Federal Reserve example essay topic

Introduction The American economy has many components which contribute to its growth and which affect its rate of inflation, but the overriding stimuli stem from the monetary and fiscal controls imposed by the Federal Reserve and government, respectively. The economy has enjoyed modest growth for several years, and that can be expected to continue. The Federal Reserve is likely to raise interest rates in late 1999 or early 2000 in order to keep the rate of inflation down; this research considers the reasons that this is likely. Analysis The Federal Reserve sets interest rates by mandating the rates at which Federal Reserve banks loan funds to other institutions. These rates then affect the rates of those institutions as they seek to maintain their profit. Thus an increase in rates by the Federal Reserve results in an increase in interest rates charged to customers by financial institutions throughout the nation.

Investors may, in this instance, move some funds out of other investments in order to take advantage of the higher rates (such as moving out of bonds), and the stock market may see a decrease in value as investors weigh the effect of the interest rate increase on corporate borrowing. The Fed held interest rates steady for most of 1997 and 1998 during which time the economy moved forward at a slow pace. Inflation was kept in check, the federal deficit declined, and unemployment was at near-record lows throughout the country. Despite this, there was little upward pressure on wages and, in general, consumers have seen some slight interest in their purchasing power. By late 1998, there was an increase in wages in some service industries and among computer and technical professionals; this has led to some increase in service prices.

Consumer spending as measured through retail sales generally increased throughout the country during 1997 and 1998 with sales of durable goods (such as home furnishing and appliances) posting steady increases. These increases indicated that the economy continued to experience growth, but at a slow pace. This growth was also reflected in manufacturing where gains were seen in the Midwest and east. Construction materials and related goods were particularly strong while electronic goods have suffered somewhat in 1998. This decline in electronic goods was thought to be related to the crisis in Asia which dampened demand for American goods in the short-term (Kraus, 1998, p. 20). Unemployment figures measure the percentage of the workforce that is employed, not the percentage of all Americans who could be employed and are not at any point in time.

The increase in the absolute number of Americans in the workforce and the lower percentage of unemployment means that more Americans who would typically seek employment are employed than in previous years. In other words, the economy was creating jobs faster than it could fill them, given that the labor force was expanding but the unemployment rate was declining. This does not indicate whether individuals were employed full-time or part time, or whether they had as much work as they might entirely desire ("Table A-5", 1999, p. 1). In considering where the American economy is headed over the next 12 months, it is important to remember that the economy is part of the American business environment as a whole.

Because the Fed's current board of governors has demonstrated that it is uniquely concerned with the inflation rate, it is unlikely that the Fed will permit the rate of inflation will increase significantly over the next year. So long as inflation is low and the economy is operating at a good pace, the government does not need to provide too much additional stimulus through the purchasing of goods and services. If the economy slows down, however, which is unlikely in the next year, the government will be put under pressure to step up its consumption. The next 12 months are unlikely to see significant deviation from the current economic state, but there is likely to be some alteration in Fed policy. The Fed has raised interest rates twice in 1999; another such increase is likely over the next 12 months in order to slow economic activity and prevent inflation. Conclusion The Federal Reserve recognizes that its decisions have far reaching effects throughout the economy, and that those effects can stretch well beyond the borders of the United States.

Because of this, the Fed considers many factors before it decides to move interest rates. Recent economic indicators suggest that the economy is continue to grow at a slow pace; such slow growth is generally desirable. However, there are indications in retail sales, construction and some wages that may signal more rapid growth than is generally desirable, and the unemployment rate continues to drop. The Fed may increase interest rates again in early 2000 to keep inflation from taking hold.

Exhibits ("Interest Rates", 1999, p. 1) ("Table A-5", 1999, p. 1)

Bibliography

Discount rates. (1999, August).
New York: Federal Reserve Board of Governors. Internet address: web frb. fed. us / releases /H 15/data / ww /db. txt. Kraus, J. (1998, May 7).
Supervision reforms called for to remedy Asian financial woes. American Banker, p. 20. Table A-5: Employment status of the civilian population by sex and age. (1999).