Hey there. I have an embarrassingly stupid question that I can’t seem to find an answer to.
Basically what I’m wondering is this..
When the Federal Reserve changes interest rates, does this effect the rate at which a bank loans at? If not how does the Fed cutting rates effect the average person or the average business? If it does, could you briefly explain the process or point me to someone where I can read more about this?
Thanks.
That is exactly what happens. The Fed is the “bank of last resort” and lends money to banks at the the official rate. If a bank gets there money at a high interest rate, they obviously need to loan that out at a high interest rate to make a profit. Also what they do is set the reserve requirement, the amount of assets required to be in the bank.
The Federal Reserve System directly controls several interest rates. This does not include the rate at which its member banks loan at. However, if the Federal Reserve System decreases the discount rate, then it will be cheaper for member banks to borrow. So they will increase their own reserves, and so their own interest rates will decrease (same demand for loans, and a greater quantity supplied of credit).
Try What Has Government Done to Our Money by Murray Rothbard. Here it is: http://mises.org/books/whathasgovernmentdone.pdf
I could try to explain the process here, but your best bet is to read the above book. In a nutshell, leaving out the details for simplicity, the central bank prints money from nothing and deposits it into the banking system. The end result is the overnight lending rate that banks charge each other (the Fed funds rate) decreases. The prime lending rate is arbitrarily set at 3% above this “fed funds target” by the banking system. However, it is the printing of money that causes the distortions in the economy.
How does this effect the average person or business? It creates distortions that lead to the boom-bust cycle. It causes great pain to average people when the artificial boom goes to bust.
“He who asks a question is a fool for five minutes. He who does not ask a question remains a fool forever.”
Thanks for the info guys (=
chloe - I’ll check out that book, thanks