Christopher
Eco201-1104B-05
Phase 3 Individual Project
The Federal Funds Rate is the interest rate that Federal Reserve uses to trade funds with banks. Any changes in the rate can trigger and offset chain of events that can be devastating to the economy. If a bank has to pay a higher interest rate to trade money or take out a loan then obviously the people are going to feel the effect in their pocket book. Each month the Federal open market committee meets and determines what the federal funds rate will be which in turn affects other short term interest rates. The determining rate immediately impacts the rates at which banks trade money and the prime rates for which banks best customers receive on loans. If the rate is too high then money flow drops dramatically and banks and people quit spending and essentially hold out until a better rate is reached. This effect can be felt all over the world and have a dramatic impact on the economy and economic spending.
The graph below shows how much the Federal Funds Target Rate has changed over the last decade. You can see that since 2008 it has taken a straight dive downward and has no signs of returning to its high in 2006.
Long term interest rates are different that short term interest rates in that they are not directly influenced by the Federal Funds target rate and usually investors will want a higher interest rate for a long term investment. A higher Federal rate means that banks have to pay more money to borrow which in return means that people have to pay a higher interest rate to borrow money which in return means less spending which slows down the economy and everyone feels it. This can be seen in the housing market when adjustable mortgage rates go up it means that people can only afford to borrow small amount of money, this means housing rates go down which in return lower home owners equity rates which can cause a panic and a dramatic decrease in spending. This is essentially called contradictory...