Interest Rates

In a recent interview, Susan Schmidt Bies (Federal Reserve Board Governor) spoke about the recent elevation in interest rates. She discussed the need for an increase in interest rates which would help the economy reach its full growth potential. She stated,"You cannot keep short-term interest rates below the rate of inflation -- it's too accommodative. We've got to get to what we call a neutral level."
Currently, the inflation rate is a few points higher than the interest rate. The government has plans to continue to raise interest rates slowly over time in order to balance out the economy. I would like to hear some opinions on this topic. I think everyone agrees that it's about time to start raising interest rates, but how high should they go? Who will initially be affected by the changes? What kind of an impact will this have on our current economy?


Dr. Tufte said...

This is interesting because the post was made shortly before we cover these issues in class (rather than after, or more typically not at all ... since students interests are more wide ranging than the texts).

I'd like my students to think about:
1) Why the short term interest rate should be above the rate of inflation?
2) There are a lot of different interest rates, and the inflation rate is not higher than most of them. Why is that?
3) Why one of your fellow students thinks it is time to raise interest rates. This may be right or wrong, but what basis does Skip have for saying this? Does he know something you don't?

Dr. Tufte said...

Skip, can I get you to go back and add a title to this?

Lizzie said...

According to what I got from class today, I think I will take a stab at Tufte’s question number 3. If a recession causes the AD to shift left because private spending declines the natural response will be for the SAS to shift down slowly. If we were to take the Keynesian approach, we would shift the AD back to the right with increased gov’t spending and decrease taxes and interest rates. However, we know from experience (70’s) that this doesn’t work. By bringing the gov’t spending down and increasing taxes and interest rates the situation is helped. Cutting gov’t spending takes the inflationary pressure off and then cutting regulation pushes the LAS. And as for the knowing something I don’t question….the answer is more than likely yes.

Kid said...

As Lizze mentioned the AD curve would shift to the left causing an inflation area. The one thing to keep in mind that Dr. Tufte talked about in class on Thursday is that the triangle never comes to a full close because shock will occur constantly sending the AD curve into movement. The best approach would be to decrease Government spending or creating a contractionary fiscal. This would decrease Government spending but raise taxes and interest rates allowing the AD curve to move back. The problem with this, is that it takes to long, for the Government to change taxes and its spending habits, making it a slow and tedious process. The end result is that interest rates are raised by institutions, such as banks and credit unions.

james said...

As discussrd in class the economy is booming. I have to wonder if it is growing to fast. Raising the interest rates might slow it down. Could this be a good thing?

Ned said...

If interest rates are rising, people will hold off on making investments, hoping for a higher interest rate in the near future. If the interest rate were to rise every quarter I'd be temped to wait for higher interest rates before I put money into the market. which might slow the economy down. There's got to be a reason they've kept interest rates so low. Maybe they've been trying to keep deflation down. After all, some inflation is probably better than that.

Dr. Tufte said...

Here we go, with some comments on comments. These were not great, so I won't name names.

What's going on is the Federal Reserve is starting to put the brakes on the economy. The are worried about the potential for future inflation. This typically results from AD shifting to far to the right. To counteract this they are nudging it to the left.