National Interest Rates
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National interest rates or the federal funds rates are the ones banks charge each other for overnight loans of reserve balances. In the
National Interest Rates – How Do They Work
When national interest rates, or Fed fund rates, are higher, banks borrow less money in order to maintain their reserves at a mandated level. This also means banks lend less money to people and the rates they charge are higher. Businesses will borrow less money, given the increasing in borrowing costs and obviously this will slow down an economy. Moreover, adjustable rate mortgages will become more expensive and lead to a slowdown in housing industry. On the other hand, when national interest rates decrease, banks lend more money, businesses expand and home loans become cheaper. This leads to improvements in the housing market, stimulating the overall economy.
Importance of National Interest Rates[br]
The Fed adjusts national interest rates to control inflation and to maintain healthy economic growth. Usually it takes around 12-18 months to fully realize the effectiveness of such interest control measures. As the Fed has the expertise to forecast the economy, markets look for interest rate changes and any communications from them very seriously. For example, a 25 basis points decline in national interest rates will make stocker markets go higher. However, too much increase will lead to inflation. A 25 basis points increase in Fed funds rate can control inflation. Most analysts and investors look into the communications of the Federal Open Market Committee predict what the Fed will do in terms of interest rates.
Ben Bernanke, Chairman of the US Fed, recently announced (2009) that the most important role of the Fed is to maintain investor and consumer confidence. Since national interest rates are at very low levels, the Fed is expected to raise interest rates soon.
