09 - Interest Rates Flashcards
Is interest rates a leading or lagging indicator?
Lagging
What are the important factors that we look at with interest rates for our analysis of an economy?
- level of rates
- direction they are heading
- speed & magnitude of changes
What is the interest rate (fed fund rate)
Interest rate at which depository institutions trade federal funds I.e. balances held at federal reserve banks with each other overnight.
If another bank has a shortfall in reserves, they borrow and pay a rate to the borrower.
The rate that the borrowing bank pays is determined by the two banks and the weighted average of all these is called the fed funds rate.
Rate determined by the market, but the federal reserve, through open market conditions, can influence the rate in order to reach its target.
The fed funds rate is the price of money.
How does the fed manipulate the fed funds rate
Buying and selling of bonds.
Decrease liquidity by selling government bonds. This raises fed funds rate because banks have less liquidity to trade with other banks. Increases demand
Increase liquidity by buying bonds. Lowers fed funds rate as banks have more liquidity. Increases supply.
Why is interest rates a lagging indicator
They are reactionary to GDP contractions in extreme negative and positives
