ECON332: Blog 3 – Investment, Consumption, and Interest Rates

One of the fundamental economic theories of we discuss here is the role played by interest rates and their impact on output and inflation. There are several channels through which monetary policy is expected to impact the overall economy. Note, that usually when we talk about interest rates here, we mean “real interest rates” which means that we are dealing with a stable rate of inflation. As noted by the Austrian central bank, through the interest rate channel “a raise in key interest rates triggers an increase in short-term market rates. As a result, both the real interest rate and the cost of capital rise, putting a brake on investment.” The Bank of Canada also notes:

The main transmission channel is the effect that changes in the Bank’s policy rate have on various commercial interest rates, e.g., for mortgages, for consumer loans, as well as for deposits at financial institutions. A decline in commercial interest rates reduces both the cost of borrowing and the money paid on interest-bearing deposits, which tends to encourage borrowing, spending and investing, and to discourage saving.

–Bank of Canada

In the US, it is supposed to work much the same way. At a fundamental level, the Federal Reserve has many explanations of how monetary policy works to impact employment and inflation. The mechanics of this are to utilize changes in the Fed’s familiar policy instruments as explained by the St. Louis Fed for one basic example and San Francisco for another more detailed story. The New York Fed–who actually conducts the open market operations–explains what happens in the greatest and probably most accurate detail. However, the traditional story does not seem to work well when the central bank’s balance sheet is where it is now. There were many stories about what the Fed needed to do in order to “normalize” monetary policy after the financial crisis, but that has all been thrown into reverse with the COVID-19 pandemic (https://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm). It has been emergency procedures all over again from the Fed, as they have expanded their balance sheet and made many efforts to protect the financial system (https://www.brookings.edu/research/fed-response-to-covid19/).

Furthermore, Federal Reserve economists Steven A. Sharpe and Gustavo A. Suarez have recently put together a report that shows many firms are not particularly sensitive to changes in interest rates.  As noted in their abstract:

A fundamental tenet of investment theory and the traditional theory of monetary policy transmission is that investment expenditures by businesses are negatively affected by interest rates. Yet, a large body of empirical research offer mixed evidence, at best, for a substantial interest-rate effect on investment. In this paper, we examine the sensitivity of investment plans to interest rates using a set of special questions asked of CFOs in the Global Business Outlook Survey conducted in the third quarter of 2012. Among the more than 500 responses to the special questions, we find that most firms claim to be quite insensitive to decreases in interest rates, and only mildly more responsive to interest rate increases. Most CFOs cited ample cash or the low level of interest rates, as explanations for their own insensitivity. We also find that sensitivity to interest rate changes tends to be lower among firms that do not report being concerned about working capital management as well as those that do not expect to borrow over the coming year. Perhaps more surprisingly, we find that investment is also less interest sensitive among firms expecting greater revenue growth. These findings seem to be corroborated by a cursory meta-analysis of average hurdle rates drawn from firm-level surveys at different times over the past 30 years, which exhibit no apparent relation to market interest rates.

 –Steven A. Sharpe and Gustavo A. Suarez

Notably, the Fed has made additional efforts to broadcast future interest rates and the desire for higher inflation in the medium term. We might be willing to have slightly higher inflation to get our economy moving again, by letting it get a bit “hot” and push unemployment lower. These recent announcements are “huge” news, and potentially acknowledge that things like the Phillips Curve are not as powerful as once thought, that the natural rate of unemployment might be deeply flawed, and that ‘potential GDP’ is not the stable rock we like to think it is. The Fed has responded by saying they may keep rates near zero for several years, undercutting the argument by some that this is a speedy recovery. They clearly believe the economy is weak, and will remain weak for the foreseeable future. Fiscal stimulus might change this, but the political will has not been there since the early days of the pandemic.

Questions you might answer:

  • Can the central bank affect the overall economy through the interest rate channel? How large is this effect expected to be? What do the authors above have to say about the effectiveness of monetary policy after the financial crisis and during the recent COVID-19 pandemic? You do not have to read all these papers, but choose one or two to try gain some deeper insight about policy. You may also choose to read some related news articles.
  • If the Fed is poised to keep rates low for years, and there is no impact on overall long-term investment, how can the central bank impact demand in a way that gets inflation to accelerate as they would like to see happen?
  • If the Fed is poised to keep rates low, but can’t lower them any further without going negative, how might that impact investment? Why doesn’t the Fed consider negative nominal interest rates? What are the arguments for or against that? Think about what the Fed is saying about the current state of the economy if they are saying that they will not raise rates for several years.

38 thoughts on “ECON332: Blog 3 – Investment, Consumption, and Interest Rates”

  1. The Federal Reserve is currently changing the way they look at employment levels and inflation. Recent data has shown that even in times of high unemployment, like the Great Recession, there was not a large decrease in prices. Add to that the low unemployment and historically low inflation we experienced in the past couple of years, and it has definitely prompted the Fed to rethink. There are several reasons for this new uncertain relationship, but I think that one of the reasons for this is because of technological change and globalisation. Companies can now increase their consumer base and product variety without raising prices as they can now reach more areas of the world without costing nearly as much as it would have previously. In regards to inflation, the Fed has recently announced that they will target 2% inflation, and right now inflation rate is below 1%, meaning that inflation will have to go above 2% to reach its target. With interest rates being cut to zero earlier this year, real yields–what you get on U.S. government bonds after compensating for inflation–have shrunk and some even gone negative. But even with negative real yields, investors might still choose Treasuries over other ventures (like gold or stocks) simply because it is more secure over the long run. Just like you pay insurance on a home, car, or phone the negative yields are a small cost to pay for the low risk of default that treasuries have, especially compared to the volatility of the stock market.

    1. https://www.economist.com/finance-and-economics/2020/09/03/will-the-feds-policy-shift-start-a-trend
    2. https://www.wsj.com/articles/lacking-tools-fed-pins-hopes-on-powerful-words-11600335000

  2. Just like the 2008 financial crisis, the Fed quickly responded to the negative Q1&2 data by lowering the interest rate. The systematic risk that the virus poses makes it near impossible to mitigate and is discouraging institutions from taking advantage of these low rates. Institutions and Individuals that have a lot of cash on hand are taking advantage of these rates such as big businesses, corporations, and homebuyers but aren’t helping others such as those in the airline industry. The Fed taking unprecedented actions, such as directly giving out loans to small businesses, shows just how little Jerome Powell can do in further stimulating the economy which is why he has called on Congress and the president early on to take action as well(1).

    If the Fed is keen on keeping rates this low and doesn’t see any impact on long-term investment, then I don’t think there’s much that can be done. The central bank can incentivize interest-sensitive spending with their low rates, but if investment activity doesn’t pick up then they’re going to have to take even bigger measures. The idea of a negative interest rate to stimulate the economy is one that is being touted by some economists but overall has very little data to back it up(2). Implementing a negative interest rate would discourage consumers from holding their money in banks and therefore incentivize them to invest it, take out a loan or just hold onto it. This could simultaneously hurt the bank since they would have less money to lend out and will also have to pay interest to their borrowers instead of the other way around.

    (1)https://www.wsj.com/articles/fed-again-eases-terms-for-main-street-lending-program-11604070083
    (2)https://www.cnbc.com/2020/06/12/do-negative-interest-rates-work-economists-cant-agree-on-how-effective-the-policy-is.html

  3. It is very unusual for the federal reserve to impose a monetary policy with a negative interest rate. The real interest rate can in fact be negative, but the federal reserve adjusted the nominal interest rate with the monetary policy for covid-19. The nominal interest rate has a 0-bound interest rate rule most of the time. During the covid-19 pandemic the federal reserve has been keeping the interest rate between 0% and 0.25% to encourage more borrowing and investing. The Federal Reserve Chairman, Jerome Powell, said this may last for a few years in a press conference. The main goal of monetary policy is to try and get core inflation to a sustained rate of 2% and unemployment to a more productive rate. This will continue for as long as the economy remains to be volatile for the next few years.
    A monetary policy that imposes a negative nominal interest rate would cause the opposite effect on borrowing and investing. The investments with a negative nominal interest rate will cause investors to pay interest on investments with banks, and borrowers with a negative nominal interest rate will benefit because it makes borrowing cheaper. This is another way to stimulate the economy and countries like Japan and Denmark have utilized negative nominal interest rates this year. The ideology behind this is that there is an effective lower-bound the is lower than the 0-bound interest rate, but that point has not been reached by any country. Borrowers may begin taking out their investments at the banks and be more interested in spending it in the economy when the interest rate is beyond the effective lower-bound interest rate.

  4. The central bank can affect the overall economy with interest rates. The central bank uses the federal funds rate to change interest rates which in turn changes household and business spending (1). For example, if there is an increase in the federal funds rate there will be an increase in interest rate which, will cause a decrease in spending households and businesses. If interest rates are low, they promote economic growth and encourage borrowing and investing, but if they are too low, they can cause unintended inflation. If interest rates are high, they limit consumer spending as there is a reduction in disposable income and can lead to lower inflation. The effect of a change of interest rates on the economy depends on how much they are increased or decreased. Also, the effect on the economy is dependent of how the economy has been and is doing. In both the financial crisis and recent COVID-19 pandemic the FOMC lowered the target rate of the federal funds rate to 0%-.25% (2). Through monetary policy the FED is trying to decrease interest rates and increase consumer spending. It is unknown if this is very effective or it would have been more effective to not change the federal funds rate. But, with increased consumer spending it may help with the spending decrease caused by both the financial crisis and COVID-19 pandemic.

    (1) https://www.federalreserve.gov/faqs/money_12856.htm
    (2) https://www.federalreserve.gov/monetarypolicy/2020-06-mpr-part2.htm

  5. The implications of large scale negative interest rates have had my attention for some time now. They are so filled with unknowns when it comes to their side-effects. For one, the lower the interest rate, the more people want to borrow and the less people want to save. Now, with interest rates dipping below 0% we should expect to see lending slow or even freeze, unless the Fed further incentivizes the banks to continue lending by relaxing capital requirements and encouraging them to lend. An easy lending encouragement would be to bring back the Term Auction Facility, which would allow banks to borrow from the Fed privately as to not give a public aura about them that they might be financially unstable.(Brookings)
    These are only part of the reason why the Fed would like to bring up the inflation rate and is trying to do so by avoiding negative interest rates at all cost. Just a basic inference can walk you down the path of why negative interest rates could be very bad for us. If we are in a system where most everyone will want to borrow and almost no one will want to save then there will be no money lendable for growth. We could be left in a situation where the only benefit of keeping your money in a bank could be access to a debit card.

    1.)https://econstudentblog.com/econ332-blog-3-investment-consumption-and-interest-rates/

  6. Despite everything going on in regard to COVID-19, the economy is slowly trying to make its way back to any sense of normalcy. However, there are some restrictions that the Federal Reserve, or central bank, faces. One of those is negative nominal interest rates, and why it cannot fall into the negative territory compared to other countries. The Fed might not really find any benefit by going into the negatives because it may seem like a tax and weigh down the economy instead of trying to provide relief and support (1). There isn’t really much evidence that shifting towards negative interest rates that it would help the economy in the long run.
    While going negative might not be the right course of action, or something that the Fed does any time soon, definitely keeping them low would help stimulate some type of growth in today’s climate. Keeping interest rates low would allow for firms and consumers to borrow more, thus increasing investment and output. This is the foundation of the IS curve and potentially a good start for what is going on today. Instead of bringing the interest rates to the negative side, the Fed is trying to keep them as close to 0% instead of 2% to try and increase the size of the labor market (2). Recovery is definitely going to be slow, but with low-interest rates, high borrowing, and efforts from all institutions – the economy will be sure to bounce back from these interesting times.

    1) https://www.ft.com/content/8a94b7bc-62d2-11ea-b3f3-fe4680ea68b5
    2) https://www.reuters.com/article/usa-fed/fed-touts-economic-recovery-vows-to-keep-interest-rates-low-idUSKBN2670IJ

  7. Even though the central bank has an effect on the economy undoubtably, it is interesting to look at the extent to which the Fed has influence over the economy by their implementation of different interest rate levels.
    After reading Steve Sharpe’s and Gustavo Suarez’s paper from 2013 one finds surprising discoveries about how much of changes in business behavior can be attributed to interest rate variations alone. Sharpe and Suarez surveyed 550 private sector CFOs, which had varying levels of revenue, employees, and both expected growth of capital and revenue, on plans for future investment in the event of hypothetical variation in interest rates. The results states that a shocking 68% of respondents believed no decline in interest rates would cause them to invest more. In contrast, the increase of interest rates was shown to be more impactful; however, 37% of CFOs still said that they would not change their plans regardless.
    Although these results do not show how every single business would react to the low interest rates currently in place, it does bring into question how much power the Fed has to revive the economy after the COVID-19 pandemic. As pointed out in the Wall Street Journal article, titled “Fed Signals Low Rates Likely to Last Several Years,” the Fed has already cut interest rates so low that there is nowhere to go but negative. Knowing the results of the Sharpe and Suarez study, on top of the Fed’s lack of choices in terms of the interest rate, it makes one question what can be done by the Fed to change the amount of investment and ultimately bring inflation back to the target rate, and perhaps even higher, so that they do not lose the cutting-room they have currently lost in the future. The study done by Sharpe and Suarez does not cover the CFOs reaction to negative interest rates, so perhaps that could have a positive effect on the amount of future investment.

    Sources:

    https://www.wsj.com/articles/fed-signals-interest-rates-to-stay-near-zero-through-2023-11600279214#:~:text=The%20Federal%20Reserve%20expects%20to,recovery%20from%20the%20coronavirus%20pandemic.

    https://www.federalreserve.gov/pubs/feds/2014/201402/201402pap.pdf

  8. Due to the Covid Pandemic, the economy fell to an undesirable low. Despite this, the Central has been looking for ways to improve the overall economy and is still in the process of bringing the economy back to normalcy. The central bank can control short term nominal interest rates with the federal funds rate. The economy as a whole is affected by the long term real interest rate by commercial banks on consumers. In response to the Pandemic, the Fed has acted to limit the economic damage by lending support to households, employers, financial markets and various forms of governments. (1) Through these avenues, they have encouraged banks to lend and brought interest rates down to near zero. Although this will help the economy bounce back in the short run, these policies may not be sustainable. The change in interest rates can have varying effects depending on how they are utilized. The decrease in them will promote household spending/consumption and will raise investment. On the other hand, there are negative effects to this as pulling this down too low could lead to inflation rising. This adjustment must be done in a calculated manner in order to minimize the level of inflation while lowering the rates to encourage spending. These factors do affect inflation and employment and while the effect of monetary policy is not immediate or direct, the policy does have an effect and can help, therefore being important in our recovery. (2)
    1. https://www.brookings.edu/research/fed-response-to-covid19/
    2. https://www.federalreserve.gov/faqs/money_12856.htm

  9. Low (or near zero) interest rates certainly encourage investment, but in my opinion, the effect is greatly diminished as rates approach zero or go negative. I believe the Federal Reserve carefully weighs impact to all in our society, not just large corporations. Senior citizens rely on fixed income investments, such as bonds and certificates of deposits from banks. They also tend to not borrow money. A low interest rate environment has been damaging to their retirement. Although small businesses and large corporations can borrow money at more reasonable rates, under a low interest rate policy, there has to be a bottom or floor to those rates. Banks and other financial institutions have fixed and variable costs to cover, like salaries and lease expenses. Those costs are not decreasing. Financial institutions may impose absolute bottoms or floors to interest rates to cover those costs, therefore the Law of Diminishing Marginal Returns would apply. Although the excerpt from the Bank of Canada stated that a “decline in interest rates” encourages borrowing, I do not believe that increased borrowing is directly proportional to an interest rate decline. In fact, bank stocks typically perform better in a rising rate environment, which may be a reason why the Fed is resisting a further reduction in the Fed Funds Rate. Lastly is the psychological impact of negative interest rates, which predicts economic weakness. In addition, individuals may have to pay banks for borrowing money and pay those same banks for holding their money. Sounds counterintuitive. Negative interest will likely be resisted because of the limited and diminishing positive impact.

    http://www.investopedia.com/terms/l/lawofdiminishingmarginalreturn.asp
    https://www.advisoryhq.com/articles/negative-interest-rates/

  10. The Fed sends many signals by the choices they make regarding the interest rates they choose and how long they keep them at certain levels. During COVID-19, the Fed has decided that they want to maintain low-interest rates for an extended period. This signal illustrates the struggle that our economy is facing the uncertainty of the long-term effects of the pandemic. In a USA Today article published in August, they claim that this is because the Fed seemingly has nothing to lose at this point and is keeping rates low to combat the unemployment crisis and to increase inflation. This decision makes intuitive economic sense because the long-term effects of historically high unemployment could be worse than predicted. One of the goals intended from this decision is to increase long-run investment by keeping these rates low. If this does not happen and investment, in the long run, is unchanged, there may be unintentional negative consequences. However, if rates remain low for an extended period and businesses use this perk to operate as close to normal as they were before COVID-19. The inflation problem could be reduced in consumption as opposed to investment. The fewer people laid off will lead to fewer people that see a decrease in their income could be more advantageous than an increase in investment. Individuals may choose to continue to consume at similar levels in the short run during the pandemic, speeding up the recovery if done on a nationwide scale. An increase in production, in the long run, is more likely if the impacts of the short-run are less significant. Eventually, there may be a rise in inflation caused by consumers spending more than an increase in investment.

    https://www.usatoday.com/story/money/2020/08/28/interest-rates-what-fed-move-means-stock-market-economy-savers/5648978002/
    https://www.usatoday.com/story/money/2020/08/27/inflation-coronavirus-feds-powell-unveils-plan-let-inflation-heat-up-bit/5639747002/

  11. Since the start of the COVID-19 pandemic, the Fed has lowered interest rates to almost zero. The Fed has also been buying large amounts of government bonds to keep low borrowing rates. Usually, lowering interest rates will lower unemployment rates, prevent a credit crunch, and mass bankruptcies. However, with the health and safety regulations from COVID, the unemployment rates continued to rise, and the economy entered into another recession. As the US moved further into the recession, the economy slowly started to recover which supported the Fed’s decision to keep interest rates low. The Fed is projected to keep low-interest rates until the inflation rate reaches a sustainable 2%.
    If the Fed continues to keep interest rates low without addressing or acknowledging the long term effects, then there is very little to be done. However, the effects of a continued low-interest-rate are encouraging saving, incentivizing taking out loans, and lowering the value of government bonds. While these might help large firms with a lot of cash and assets, lowering interest rates dissuades the average consumer from spending. The average consumer is trying to save their money because of the low employment rates caused by the pandemic. Large businesses will take advantage of the low-interest rates and will hopefully start to invest and expand. In the short run, lowering interest rates seems like it will stimulate the economy and increase the number of jobs. In long run, there is very little research on the effects of a sustained low-interest rate. Also, with the pandemic still going on it is hard to predict the changes in the economy when the virus is so unpredictable and there is still no vaccine.

    1) https://www.nytimes.com/2020/09/16/business/economy/federal-reserve-interest-rates.html#:~:text=the%20main%20story-,Fed%20Pledges%20Low%20Rates%20for%20Years%2C%20and%20Until%20Inflation%20Picks,zero%20at%20least%20through%202023.
    2)https://www.usatoday.com/story/money/2020/11/05/fed-interest-rate-officials-keeps-rates-near-zero-vows-more-action-if-economy-weakens/6174888002/

  12. Interest Rate in the United States averaged 5.59 percent from 1971 until 2020, reaching an all-time high of 20 percent in March of 1980 and a record low of 0.25 percent in December of 2008 (1). Currently we are still at this all-time low rate of 0.25 and this is going to stay for a decent amount of time, with the incentive for individuals to invest or borrow. The goal is to get our economy to slowly grow with low interest rates and large amounts of borrowing. Another option for the Fed is to impose negative interest rates which seems timely unrealistic. If negative rates were to be applied, there would be more pressure from banks to give out loans. The banks could charge interest for individuals keeping money within the banks (4). These rates would pressure individuals to invest their funds more largely, rather than hold it within the banking system. Any Monetary Policy to impose a negative interest rate is going to be controversial but has potential to increase investment/borrowing nationwide. As seen in other foreign countries.

    For the sake of Inflation, the Fed is concerned with its goal of a 2 percent inflation rate. One goal of the Fed is to tighten our labor market which is fantastic for the unemployment rates and the future of the economy (2,3). To achieve this, the Fed may have to raise inflation rates above 2 percent for some period for it to average out. This would cause people to save on credit card interest, but subsequently cause mortgage rates to increase, as well as lower future incomes. The Fed is wanting to change future inflation for the sake of investment, but not put us into a critical situation like Europe and Japan’s economy have been facing for years on end (2).

    (1) https://tradingeconomics.com/united-states/interest-rate

    (2) https://www.wsj.com/articles/fed-signals-interest-rates-to-stay-near-zero-through-2023-11600279214#:~:text=The%20Federal%20Reserve%20expects%20to,recovery%20from%20the%20coronavirus%20pandemic.

    (3) https://www.marketwatch.com/story/the-fed-has-adopted-a-new-approach-to-inflation-heres-what-it-means-for-your-wallet-2020-08-31#:~:text=What%20did%20the%20Fed%20change,for%20a%20period%20of%20time.

    (4) https://www.bankrate.com/banking/federal-reserve/how-negative-interest-rates-work/

  13. Historically, the Fed has been known for decreasing interest rates during economic downturn however in more way than one, this virus shifted us to unprecedented times has led to somewhat similar policies. Typically the Fed reduces interest rates to reduce the cost of borrowing to stimulate the economy and discourage saving. However, the current economic status has led to an idea of a negative interest rate enacted my monetary policy. If this policy is followed by people pouring back into the economy instead of saving, then it will assist in getting the economy back on its feet. This only heightens when regulatory requirements are relaxed increasing the likely hood for small businesses and households to invest. In that case, inflation would rise and hopefully stabilize.

    However there are major consequences and concerns that could be drastic if those who take advantage of these low prices, only save because the plan for the COVID future is unknown. This would deplete the money source of banks and leave a distaste for lending and losing.

    To try to minimize these risks, the Fed has cut the federal funds rate to support the economy and financial markets. This will lower the cost of borrowing from bank to bank to encourage financial transactions and moving money around that way none will become depleted. Yet, since negative interest rates are a topic not touched upon greatly, the long term effects are unknown and time will tell when increasing interest rates is right once the economy begins to shift out of the current status it is in.

    1. https://www.brookings.edu/research/fed-response-to-covid19/
    2. https://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm

  14. If the Fed continues to keep interest rates low for the foreseeable future which recently discovered; does not have an impact on overall long-term investment, it is left up to the central bank to impact the overall demand from consumers. One of the things the central bank can do is commit to expansionary monetary policy. This will increase the supply of money circulating in our economy giving banks more money to lend. This will in turn lower the cash rate for banks to lend making it more enticing for consumers to borrow and consume which would drive up consumption and demand (2). The increase in money going around purchasing the same amount of produced goods will cause firms to want to drive up their prices. This will lead us to accelerate our inflation as desired as long as the central bank is increasing the money supply faster than the growth of output (1). A separate thing to keep in mind is that the central bank needs to be careful not to overshoot this increase in aggregate demand. As we know prices eventually adjust on their own and if they do so during the lag stage of the aggregate demand increase, we may put ourselves in a position where the inflation rate is too high and therefore harming our economy (using IS/LM/BP analysis).

    For now, the Fed wanting to keep interest rates low says that they are not yet seeing an advancing change in consumer spending and thus not getting us back on track quite yet. Naturally, to speed up this process one might think that the Fed can lower the interest rate even more which will eventually further encourage spending. Interest rates are already at record lows. Any lower and we’re threatening turning the rates negative. The reason why this is not a viable option is because if interest rates are negative, it would mean that banks would be paying consumers to borrow money. Even though this would attain what is desired, it would make it costly to leave money in savings and make operating cost for banks much too high (3). It is a smart move to keep interest rates low but not too low and while they are low the central bank has to be creative to increase demand while not putting us into a worse state.

    1.) https://www.economicshelp.org/blog/111/inflation/money-supply-inflation/#:~:text=Increasing%20the%20money%20supply%20faster,firms%20to%20put%20up%20prices.
    2.) https://medium.com/@m.haines_81949/how-can-the-central-bank-use-monetary-policy-to-influence-aggregate-demand-7104aaeaf4bc#:~:text=As%20is%20commonly%20understood%2C%20Central,interest%20on%20loans%20to%20customers.
    3.) https://www.investopedia.com/terms/n/negative-interest-rate.asp#:~:text=A%20negative%20interest%20rate%20environment%20occurs%20when%20the%20nominal%20interest,than%20receiving%20positive%20interest%20income.

  15. The Fed has made it clear that it wants to keep interest rates low for the foreseeable future. (1) The main goal of the Fed lowering interest rates is to spur economic growth by incentivizing businesses to invest for the future while simultaneously incentivizing Americans to spend their income now. The strangest thing is that Americans are so incredibly scared, that the low interest rates do change their willingness to save. Regardless of the decrease in interest rates, Americans are still choosing to save rather than spend. This is because there not a huge correlation between interest rates and saving in the short run at all. Rather, saving is influenced by expansionary and recessionary periods in the short run, and interest rates in the long run. (2) This is troublesome because it gives off the impression that the Fed does not have as much control over the public’s demand as many believe.
    How low can the Fed lower interest rates? It is conceivable that an interest rate could go so low as to having a negative return. Why would anyone ever do this? In the country’s current situation, it would not be too farfetched to say that an American that is scared for the future would invest in a virtually riskless bond with a negative yield. They would do this because they desire, more than anything else, security. They are willing to pay the cost of the negative yield so that their money will be safe for the future. (3) This further proves the concern that the Fed does not have an incredible amount of control over the public’s demand.

    1) https://www.wsj.com/articles/fed-signals-interest-rates-to-stay-near-zero-through-2023-11600279214#:~:text=The%20Federal%20Reserve%20expects%20to,recovery%20from%20the%20coronavirus%20pandemic.
    2) https://www.economist.com/finance-and-economics/2020/10/17/low-interest-rates-leave-savers-with-few-good-options
    3) https://www.wsj.com/articles/five-reasons-why-investors-might-buy-negative-yielding-debt-11601840568

  16. The Federal Reserve is facing its toughest challenge in recent history while attempting to stimulate the economy and lower unemployment. Currently, the Fed has stated an intention to keep interest rates close to zero for around three years, but this is proving to be costly as businesses have not been receptive at large to these lower rates (1). If this trend continues without any increase in long-term investment, there are very few moves left to make except for lowering the interest rate even further into negative territory. Thus far, Jerome Powell has stated that he does not intend to lower the interest rate below zero, citing a lack of clear data on its effectiveness and the potential negative interest has to hurt banks since people will be incentivized to hold onto cash instead of putting it in banks (2). While these points are certainly valid and have been noted by multiple students, one overlooked factor by many in this forum is that moving to a negative nominal interest rate is not necessarily crossing a border in real dollars adjusted for inflation. In long-term, real dollars, a nominal interest rate close to zero is already negative, and while that should not be treated as a reason to bring interest rates too low, the Federal Reserve should not be afraid of negative territory because it is a line that has been crossed many times. Seeing as Sweden’s Riksbank, the oldest central bank in the world, put in a negative rate in 2009 and many more throughout Europe have followed since (3), negative rates are not as murky as they may seem, and since a zero nominal rate is already a real negative rate, the drawbacks to lowering it further should not be looked at as a drastic new measure.

    (1) https://www.federalreserve.gov/pubs/feds/2014/201402/201402pap.pdf
    (2) https://www.cnbc.com/2020/06/12/do-negative-interest-rates-work-economists-cant-agree-on-how-effective-the-policy-is.html
    (3) https://www.bankrate.com/banking/federal-reserve/how-negative-interest-rates-work/#:~:text=Negative%20interest%20rates%20are%20exactly,Fed's%20main%20economy%2Dguiding%20lever.

  17. In times such as now when the economy is in a recessionary period and the Fed has pledged to keep rates near-zero (1), they will need to employ other measures through separate channels in order to jump start economic growth. This can be done with interactions with commercial banks and increases in the money supply.
    Through the reserve requirement, the Fed can pull back restrictions on commercial banks by allowing for them to lend out more money to consumers and businesses (2). With less money required to be held by banks, they may lend it out to potential new and old businesses helping to reverse or lessen the impact the Corona Virus has had on small businesses. This would also mean there is more money going out into circulation and not simply sitting in a bank vault.
    Another way the Fed may achieve higher circulation of money in the economy would be through open market operations of buying and selling bonds (2). Allowing more money into the economy through the two mentioned situations would hopefully increase demand as more consumers and businesses would be enabled by an inflow of currency whether it be through a loan or a bond transaction, thus accelerating inflation in hope of it reaching the 2% threshold the Fed seeks to at least maintain sometime in the future (1).
    (1) https://www.wsj.com/articles/fed-signals-interest-rates-to-stay-near-zero-through-2023-11600279214#:~:text=The%20Federal%20Reserve%20expects%20to,recovery%20from%20the%20coronavirus%20pandemic.
    (2) https://www.stlouisfed.org/in-plain-english/how-monetary-policy-works

  18. The central bank has control over the federal funds rate, which is how they can control the interest rates and in turn affect the whole economy. This is important because the change in interest rates affects how much businesses and households spend and save. The higher the interest rate the less spending there is, this is because of the high borrowing cost of money. Conversely, the lower the interest rates the more households and businesses will borrow, spend, and invest. Since the COVID-19 pandemic, the central bank has lowered interest rates to try and promote and stimulate the economy. But, with record-high unemployment, numerous businesses closed for good, and the number of cases steadily increasing the change in interest rates has not had the effect the central bank wanted. The pandemic put a hold on the economy like no other, it has significantly stopped spending and investing and highly prioritized saving. And even the best efforts from the central bank to reverse the incentives, we won’t have a full recovery of our economy until we have an effective vaccine for this virus.

    https://www.federalreserve.gov/faqs/money_12856.htm

  19. Controlling the interest rates in not the Federal Reserve’s only tool in the Fed’s toolbox. It would be entirely possible for the Fed to spur inflation while maintaining low interest rates by steadily increasing the amount of money in circulation. When the money in circulation increases, there is more money available to buy goods with, causing a surge the demand for goods and services, since consumers are essentially able to consume more. This increased demand for goods causes the price of goods to rise and as a result, the Fed has achieved their goal of kick-starting inflation while still maintaining low interest rates.

    This can be shown by the economy’s response to the stimulus checks given out by the Federal Government during April 2020. Although this action was not taken directly by the Federal Reserve, it still demonstrates how changes in the money supply can affect inflation. Prior to COVID-19 making its way to the United States, the Effective Federal Funds Rate (EFFR) was stable around 1.55%-1.60% throughout November 2019 to February 2020. During March 2020, the EFFR rapidly dropped until April 2020 where the rate bottomed out at 0.05%. Since the stimulus in late April it has increased slightly, rising to 0.09%. However, this is tiny increase compared to how hard the EFFR fell from where it was in November 2019 (1).

    The Consumer Price Index (CPI) has a different story. During November 2019, the CPI was situated at 252.662. It peaked during February 2020 at 259.050 and at the advent of the COVID-19 pandemic, dropped down to 255.092 in April 2020 and began to feel the effects of the stimulus by June, rising to 257.214 and has continued to grow, and is currently 260.209 (2).

    Using CPI as a measure of inflation, and EFFR as a measure of interest rates, the COVID-19 stimulus exhibits how increasing the money in circulation will lead to inflation while maintaining low interest rates. Post-stimulus, the CPI has completely rebounded and passed its value in November 2019 and is still growing (1). The EFFR has since increased, but by less than one-tenth of a percent, became stagnant, and continues to be nowhere close to the rate posted in November 2019 (2).

    (1) https://fred.stlouisfed.org/series/DFF
    (2) https://fred.stlouisfed.org/series/CPIAUCSL

  20. COVID-19 has brought the Fed to reconsider many aspects of monetary policy, and what was previously considered to be “normalized”. Considering the ongoing effects of the pandemic, the Fed has decided to keep interest rates near zero for years. Low interest rates can allow for higher levels of investment and borrowing for both firms and individuals, allowing them to afford an higher level of employment and production. With this policy, the Fed is prioritizing maximizing employment rather than focusing on regulating inflation spikes. The Federal Reserve expects a median unemployment rate of 7.6% for 2020, drastically decreased from April’s unemployment rate of over 14%. They are also projecting benefits for GDP. The now projected decline of 3.7% for the year shows the benefits of implemented monetary policy and decreases in interest rates, as the decline was estimated at 6.5% in June. The Fed hopes that their continuation of very low interest rates will strengthen demand throughout the economy and raise prices. They hope for the economy to eventually return to its full strength by allowing greater opportunities for businesses, with rising employment rates allowing businesses to produce more and individuals to consume more, and inflation rates to revitalize the economy. The targeted annual inflation rate is 2% to keep growth sustainable and increase the expectations of investors, businesses, and consumers. Although the future is largely unknown due to the pandemic, the Fed is attempting to strengthen the economy through monetary policy, specifically pledging to keep interest rates near-zero for years to come. These policies have been effective thus far, allowing some recovery since the dramatic economic drop when the pandemic began its initial spread, though it will be interesting to see if they remain effecting throughout COVID’s duration. Particularly, will these measures be enough to protect the economy if there is a dramatic second wave, or if medial precautions are necessary for years to come?
    https://www.wsj.com/articles/fed-signals-interest-rates-to-stay-near-zero-through-2023-11600279214#:~:text=The%20Federal%20Reserve%20expects%20to,recovery%20from%20the%20coronavirus%20pandemic.
    https://www.nytimes.com/2020/09/16/business/economy/federal-reserve-interest-rates.html?auth=login-email&login=email
    https://www.cnn.com/2020/09/16/economy/federal-reserve-september-meeting/index.html

  21. The effects of a negative interest rate have not been totally proven yet. In theory negative interest rates would greatly reduce savings while borrowing should grow immensely. With negative interest rates commercial banks may be encouraged to loan out money they otherwise might keep in reserves earning interest. In practice, negative rates don’t always equate to banks loaning more. If negative rates are placed on depositors’ people may want to hold more money in cash instead of in the bank, lowering a banks capacity to lend. The bank’s unwillingness to lend would Jerome Powell and the Fed are currently trying to keep interest rates near zero, however they do not want them to go negative. Powell stated that negative interest rates was not an appropriate tool to use in the United States economic recovery from COVID-19.

    The Fed clearly seems cautious about the economic recovery to come in the U.S., however they only have so many tools to deal with the current recession. As stated above, the Fed is aiming to keep interest rates near zero (but certainly not negative) for some time. Economists project that interest rates could be near 0 for the next three years, even with inflation hitting 2 % and unemployment dropping to 4%. This shows the Fed’s cautious approach to recovery in this economic crisis. They are seriously concerned for the long-term implications of COVID on the economy and want to do all they can to tend to those long-term concerns. The final tool Jerome Powell and the Fed are using is their words. By using words like “powerful” when talking about economic recovery but not exactly making changes that would reflect a strong recovery, Jerome Powell is trying to spur confidence in the economy. The Fed is hesitant to believe we have a strong recovery coming our way quickly, but they are using the tools they have such as reaching near zero interest rates and trying to instill confidence through their platform to promote a long-term recovery.

    https://www.wsj.com/articles/fed-signals-interest-rates-to-stay-near-zero-through-2023-11600279214#:~:text=The%20Federal%20Reserve%20expects%20to,recovery%20from%20the%20coronavirus%20pandemic.

    https://www.cnbc.com/2020/06/12/do-negative-interest-rates-work-economists-cant-agree-on-how-effective-the-policy-is.html

    https://www.cnbc.com/2020/05/13/powell-says-the-federal-reserve-is-not-looking-at-negative-interest-rates.html

  22. In theory, the Fed can affect the economy with interest rates. While some may question the effectiveness of monetary policy and its ability to affect the economy, the thought is that by lowering interest rates, the cost of borrowing is lower and therefore businesses and people will be more likely to borrow money and help bring the economy out of a recession. This generally works both ways as well, if the economy doing well, interest rates will be raised to because businesses and people are more likely to be able to afford the higher cost of borrowing. Economists have started to question whether monetary policy and changing of interest rates are really making that much of an impact on the economy and investments. In the paper by Steve Sharpe and Gustavo Suarez they go on to note that many firms, especially in an economic downturn such as the latest, are not swayed into investing when lower interest rates are put in place. They even go on to suggest that firms are more sensitive when interest rates go up than when they go down. Based on these economists stance they likely believe that the economy is in a recession and continue to be in a recession because people and businesses have a small reaction to a change in interest rates.
    https://www.federalreserve.gov/pubs/feds/2014/201402/201402pap.pdf
    https://www.investopedia.com/articles/investing/010616/impact-fed-interest-rate-hike.asp
    https://www.federalreserve.gov/covid-19-faqs.htm

  23. The United States uses a very detailed and thought out plan when it comes to the need to utilize their monetary policy. More specifically, with the recent COVID-19 pandemic it, the US focused on policies that dealt with inflation and employment. With that being said, the primary tool within the monetary policies to help target these issues is the federal funds rate. More specifically, the rate that the banks will have to pay in the federal funds market for overnight borrowing (1). When there are changes in these federal finds rate, they happen to change or influence other interest rates, which then snowballs towards influencing the borrowing costs for things like businesses and households as well (1). This is very good for the economy because it helps control that inflation and helps encourage a healthy economic growth. The lower we have the federal funds rate, the lower the interest rates are, leading to lower mortgages, credit, and just consumer savings in general. Macroeconomics can be seen to have several of these snowball-like positive effects. For example, in class, a topic of discussion was the multiplier effect and how to naturally shows a continuing chain of new household income and firm revenue.

    In order for these policies to work smoothly for the United States, it is important to make sure that the monetary policies are normalized. With a hasty generalization of what is to come of the economy in the future, the process of normalizing is going to have to be data-driven (2). This includes strict measurements of inflation, GDP, and labor market performances (2). In order for the Fed to work quickly in an attempt to predict accurate future performances, the Fed must strictly follow the steps for monetary policy normalization given by the FOMC. Having a step by step plan of action gives the normalization of monetary policies a greater chance for future success.

    (1) https://www.federalreserve.gov/faqs/money_12856.htm

    (2) https://www.stlouisfed.org/publications/regional-economist/july-2015/ask-an-economist/

  24. Between the end of 2008 and the end of 2015, the federal funds rate hovered around 25bps. At the beginning of 2016, the rates began hiked up to 2.44% followed by a steep drop-off in April 2019 to present-day (FRED). When the fed lowers interest rates, it encourages additional investment, consumption, and borrowing. Lower Interest rates are often in effect when the economy is not healthy. These low rates discourage savings and increase investment–an attempt to artificially stimulate the economy until it returns to a healthier state.

    Besides Trump’s tweet “As long as other countries are receiving the benefits of Negative Rates, the USA should also accept the “GIFT”. Big numbers!” the Fed has had no reason to consider negative nominal interest rates. The economy hasn’t been in a position where it would need negative rates to stimulate it. You could argue Covid-19 should have sent rates negative to stimulate investment but the 2 trillion-dollar relief package sufficed. Negative interest rates come into play when deflation is strong enough and aggregate demand has fallen dramatically. Negative interest rates are an option when dropping rates to the zero-bound have failed to stimulate consumption, borrowing, and investment.

    Negative interest rates could have a positive effect on the economy if the Fed was able to recognize when to raise them back to normal levels. The biggest issue with negative rates is the Fed’s inability to return them to normal. Going back to the first 2 sentences rates were kept near the zero-bound for 8 years, hiked to almost 2.5%, and then pulled back down to near zero-bound. The economy has become addicted to these low rates and needs them to continue current practices, the inability to withstand higher rates correlates with a weaker American economy.

    If the Fed is saying they will not raise rates (from a rate near the zero-bound), they are assuming the economy is going to need stimulation for the duration of that time in order to avoid a recessionary period.

    (1)https://fred.stlouisfed.org/series/EFFR

    (2)https://www.investopedia.com/terms/n/negative-interest-rate.asp#:~:text=A%20negative%20interest%20rate%20environment%20occurs%20when%20the%20nominal%20interest,than%20receiving%20positive%20interest%20income.

  25. After another speech by the FOMC and J Powell, rates are going to stay near zero. According to a press release today, the committee is poised to keep rates low until inflation reaches two percent over the long-run. To achieve this, inflation in the short-run must be above two percent, and the FOMC’s goal is for inflation to stay moderately above two percent and to maximize employment (Fed press release 11/5/20). Economic theory predicts that increasing interest rates negatively impact investment from businesses, but a research survey of CFOs reported that not all firms are equally sensitive to increasing interest rates. The level of cash is cited as a reason for insensitivity (Sharpe, Suarez). If a business has a higher level of cash on hand, they will be affected less by increased rates. Similarly, if rates go negative and companies must pay to keep their required level of reserves, those with more cash will not be as affected.

    The Fed is not considering negative interest rates despite President Trump’s suggestion (Cox, Powell says). Proponents argue lowering borrowing costs even further to incentivize lending. However, negative rates have not been proven effective. Banks could continue their current trend of decreasing available credit. It may be more difficult to receive loans (Dickler, Here’s what negative). Interest rates rise during economic booms and fall during recessions. If the Fed is not considering raising interest rates for years, that could mean they foresee a longer-lasting recession where rates must remain low.

    Sources:

    https://www.federalreserve.gov/monetarypolicy/files/monetary20201105a1.pdf

    https://www.federalreserve.gov/pubs/feds/2014/201402/201402pap.pdf

    https://www.cnbc.com/2020/06/10/heres-what-negative-interest-rates-from-fed-would-mean-for-you.html

    https://www.cnbc.com/2020/05/13/powell-says-the-federal-reserve-is-not-looking-at-negative-interest-rates.html

    https://www.wsj.com/articles/fed-signals-interest-rates-to-stay-near-zero-through-2023-11600279214#:~:text=The%20Federal%20Reserve%20expects%20to,recovery%20from%20the%20coronavirus%20pandemic.

  26. If the Fed continues to keep interest rates low, it will prompt american citizens to increase their borrowing and increase investment. The reason for the Fed doing this is because of the effect of the Covid-19 pandemic on our economy. In fact, since the pandemic hit the United States, our GDP has reached the largest decrease in percentage points year over year of the century according to the federal reserve economic data. This is why the Fed is keeping interest rates low as they often do during recessions in order to increase investment spending.

    Due to the fact that interest rates near zero lead to increased borrowing and investment, the question emerges of why doesn’t the Fed implement negative nominal interest rates. There would be some benefits to this such that in theory this would increase investment, spending, and borrowing even more than near zero positive rates. However this could be dangerous as negative interest rates could lead to high inflations. Higher than the amount that the Fed would like. Negative nominal interest rates would also discourage saving money. Whereas both consumers and businesses would be theoretically losing real buying power if they held on and saved money during a time with negative rates. This could be very risky because if something goes wrong like another recession, a disaster, or any significant shock to a business or consumers, having little to no money saved would be a serious problem and potentially very dangerous.

    The fact that the Fed is saying that they are planning to keep interest rates low for a few years indicates that they think the health of the current economy is unstable and possibly volatile to the extent that monetary policy needs to stimulate growth for our economy. This also indicates that an increase of inflation is not one of the Fed’s main concerns right now and in fact might be willing to increase the rate of inflation if necessary.

    https://fred.stlouisfed.org/series/GDP

    https://www.nytimes.com/2020/09/16/business/economy/federal-reserve-interest-rates.html

  27. The Federal Reserve’s main method of conducting monetary policy by changing the federal funds rate is becoming less effective. Interest rate changes are no longer producing the economic expansion or retraction they once did. This is partially due to the fact that investment strategies are using a required rate of return not closely connected interest prices. In one poll 68% of CFOs say they wouldn’t expect to alter their investment strategy at any interest rate. Banks are also becoming less sensitive to interest rates. The supply of reserves became so large after the 2008 financial crisis that a change in the interest rate no longer has a substantial effect. This is because in pre-crisis times the fed funds rate fell along a downward sloping demand curve of reserves. Post-2008 new reserves were created at such a high level that the vertical supply of reserves because the fed has a monopolistic control of reserves, intersects the demand curve at a flat section. This means that the fed may have to select other tools when it comes time to raise rates. These include increasing the IOER rate, offering RRPs, and offering term deposits. The time to raise interest rates will not come for a while, but when it does it may be difficult. For now, the main problem will be if the output isn’t increased by near-zero interest rates. If this is the case the Fed has stated several times that they would prefer fiscal policy to be enacted. Negative rates have worked out poorly for countries like Sweden and they aren’t likely to work for the U.S either.

    https://www.federalreserve.gov/pubs/feds/2014/201402/201402pap.pdf
    https://www.federalreserve.gov/econresdata/feds/2015/files/2015047pap.pdf
    https://www.ft.com/content/478fe908-5168-11ea-8841-482eed0038b1

  28. •The central bank has a large influence on the aggregate economy through interest rates. The primary tool the Federal Reserve uses is the federal funds rate, which is the rate that banks have to pay for any overnight borrowing in the federal funds market. Any changes to these rates have large impacts on other interest rates that influence the borrowing costs for households and businesses (1). During the COVID-19 pandemic, the Fed cut the funds rate target by 1.5%, bringing the range down to a 0% – 0.25% target. The steps the Fed takes to buoy the economy are large. Since states are locking themselves down to mitigate the spread of the virus, spending has been very limited and has hurt many households and businesses. The Fed is trying to ensure that credit keeps flowing to these struggling businesses and households (2).

    •Since the Fed cannot increase demand with fiscal policy, they instead create an environment in which interest rates are low, leading to lower borrowing costs and higher asset prices, which is supportive of increased spending (3). The Fed currently has a target of 2% inflation, and they will do things such as keep rates low and purchase trillions in assets to keep markets liquid as well as create hospitable environments for spending and investing.

    •Regarding negative rates, instituting a negative interest rate would adversely discourage people and businesses from putting their own money in banks but instead will lead them to investing in equities/alternatives or using the money to buy homes. This would hurt banks, causing them to become less liquid and less able lend money.

    1) https://www.federalreserve.gov/faqs/money_12856.htm
    2) https://www.brookings.edu/research/fed-response-to-covid19/
    3) https://www.investopedia.com/ask/answers/081915/how-can-federal-reserve-increase-aggregate-demand.asp#:~:text=Some%20typical%20ways%20fiscal%20policy,mechanism%20to%20reach%20its%20goals.

  29. One way the central bank can increase inflation is to keep cutting or lowering the interest rate. If interest rates are low, investment and economic activity goes up. Therefore, inflation goes up. Increasing interest rates can slow down the progress of decreasing unemployment and cause wage stagnation, when higher wages are needed to increase inflation (3 and 4). An example of this, where the government cut interest rates and taxes, is when the UK was going through a rapid economic growth in the 1980s (4). “Positive wealth effect and a rise in consumer confidence … led to higher spending, lower saving, and increase in borrowing” (4). With higher wages allows workers to consume more, which leads to increased investment and economic activity. Another way to increase inflation is to increase money supply faster than the output growth, because only increasing money supply and not in output leads to increase in prices (1). The Fed can’t not print money to increase the supply; instead it can lower the reserve requirements for banks (2). That way banks are able to lend more money with low interest rates, which in theory will increase consumption and demand for goods and services.

    (1)https://www.economicshelp.org/blog/111/inflation/money-supply-inflation/
    (2)https://www.investopedia.com/ask/answers/07/central-banks.asp#:~:text=The%20Fed%20can%20increase%20the,size%20of%20the%20money%20supply.
    (3)https://populardemocracy.org/news/mind-gap-how-federal-reserve-can-help-raise-wages-america-s-women-and-men
    (4)https://www.economicshelp.org/macroeconomics/inflation/causes-inflation/

  30. When the Fed sets relatively low interest rates, they are predicting that this will help stimulate the economy by decreasing saving and increasing investment, whether that be through hiring employees, increasing capital, encouraging consumers to spend more, etc. However, in the long run, these low-interest rates may lead to inflation, which in turn decreases buying power and may eventually counteract the positive growth.
    If the Fed were to use negative nominal interest rates, it would disincentivize commercial banks from keeping excess reserves at the FED. Instead of receiving interest, the banks would be paying interest on their own money. Thus, there is an incentive for banks to spend or invest excess cash. Negative interest rates also encourage consumers to withdraw their money from the bank and then borrow money to turn a guaranteed profit. This all contributes to devaluing the currency.
    On the other hand, negative interest rate policies (NIRP) are in theory intended to be used as a short and quick way to boost the economy and trade and to get inflation back up to target. Withdraws may not see a hike because of the Insurance of the Federal Government. Central banks like the ECB (Europe) and BOJ (Japan) started using negative rates in 2014 and 2016 respectively, and as of July 2020, they have rates of -0.5% and -0.1%, respectively. The US FED sees NIRP’s as a recent experiment that could cause other economic problems. They decided instead, to cut rates to nearly zero and buy up risky assets, similar to their conduct during the Great Recession.
    The FED is implying the economy will stay relatively stable with their claim that they will not raise rates until 2023. Inflation will gradually increase and unemployment will trend low. This projection is likely founded on the estimated time required to recover from the dampened economic activity during the pandemic and the acceptable bullish period before inflation needs to be pulled down again.

    https://www.investopedia.com/terms/n/negative-interest-rate.asp#:~:text=A%20negative%20interest%20rate%20environment%20occurs%20when%20the%20nominal%20interest,than%20receiving%20positive%20interest%20income.
    https://www.bankrate.com/banking/federal-reserve/how-negative-interest-rates-work/
    https://www.usbank.com/financialiq/invest-your-money/investment-strategies/how-do-interest-rates-affect-investments.html

  31. In recent months, the Fed has implemented an unprecedented monetary strategy in hopes to rebuild the American economy. Among other policies, the central bank has cut the Federal Funds rate to near zero, employed an open-market-operations strategy that has accrued over six trillion dollars in securities, and has even begun lending to individual consumers and small businesses who hold asset-backed securities (1). The Fed’s initial response to the collapse of the economy was aggressive and fast-acting. Its purpose was two-fold; first, stabilize credit channels to prevent another financial crisis and second, lay the groundwork for longer-term economic recovery. By decreasing the federal funds rate, engaging in open-market-operations, lending to banks and securities firms, and relaxing reserve requirements, the central bank has successfully prevented insolvency issues from damaging the financial industry (1).
    Beyond mitigating financial risk, the Fed is hoping its policies will help kickstart a reemergence in investment, employment, and overall output. In addition, the Fed is targeting an inflation rate that will run “moderately above 2% for some time” says the Wall Street Journal (2). Where the Fed moves from here will depend on how the economy responds to these policies. If it is the case that near zero interest rates do not spur investment and inflation at the rate the Fed is hoping, new strategies will have to be implemented. Although there are not many monetary policies left for the Fed to attempt, former Fed chairs Ben Bernanke and Janet Yellen have theorized a few additional steps the central bank could take. These strategies include expanding lending facilities, restarting the Term Auction Facility, (a less stigmatized alternative to the discount window), broadening the range of financial firms that can borrow from the PDCF, and lastly implementing a yield curve control policy (a strategy that has not been implemented since 1951) (1). Chairman Jerome Powell has assured that all decisions moving forward will be data driven and unconfined to predetermined plans or theories. Whatever the economies response is, important lessons will be learned regarding monetary policy and its impact on economic stabilization.
    1. https://www.brookings.edu/research/fed-response-to-covid19/#:~:text=Through%20three%20programs%E2%80%94the%20New,in%20annual%20revenue%20can%20participate.
    2. https://www.wsj.com/articles/fed-signals-interest-rates-to-stay-near-zero-through-2023-11600279214#:~:text=The%20Federal%20Reserve%20expects%20to,recovery%20from%20the%20coronavirus%20pandemic.

  32. Because of Covid-19, there are influence a lot of company, people and economy. In order to support the U.S. economy and financial markets, the fed is doing a lot, which include near-zero interest rates, supporting financial market functioning, encouraging banks to lend, and supporting corporations and small businesses.
    For near-zero interest rates, it’s means bringing down the federal funds rate to 0-0.25%. For long term, it will impact people borrowing on mortgages, auto loans, college loans and other loans. But that will impact interest income from the savers get. And using near-zero interest rate, maybe will achieve the goals of maximizing employment and stabilizing prices.
    For Supporting corporations, it’s resumes purchase of securities. For securities is an important tool during the great recession. And during that time the Fed bought trillions of long-term securities. But when COVID-19 happened, the securities market has become dysfunctional. The author said that because of the COVID-19, when the fed resumes purchase of securities, the market become stabler than before.
    For supporting small business, it’s let small business to loans, and expanded the loan amount. And there will lead to people create their small business during COVID-19. For example, we can see they are more and more restaurants are emerging in Harrisonburg.

  33. Under normal circumstances, when interest rates decrease, investment increases and as a result short-run output also increases. The Fed is currently targeting a Federal Funds Rate between 0 and .25%. Due to the COVID pandemic the market was not responding to this low interest rate as we would expect. Most businesses took major losses as a result of the pandemic and are unwilling to invest at the moment. The situation is getting better as the economy, as an objective whole, is trending in the right direction. Investment in the first quarter of 2020 was 3.334 trillion dollars and fell to 2.8498 trillion in the second quarter. This was a quarter over quarter decline of -14.5%. Investment in the third quarter increased at a rate of 16.3% to 3.3145 trillion dollars. Investment is only down from the third quarter of 2019 by 3.8%. This could indicate a lag and that things are getting better. GDP is only down about 2.9% from the third quarter of last year. This is a lot closer than the roughly 9.1% it was down in the second quarter compared to the second quarter of 2019. Short run output is only about -3.5% below potential compared to the third quarter of 2019 where it was roughly 1.1% above potential. The economy is not recovered, and things are still bad for many people, but it looks like investment is on the rise.
    Again under normal circumstances, if the Fed were to implement a negative interest rate it would lead to increased investment. The Fed might consider a negative interest rate because the unemployment rate is about 3.5% (7.9 – 4.4) above natural unemployment. The Fed’s new approach to the interest rate is to allow inflation to grow relatively freely. This should reduce unemployment as increasing inflation usually causes unemployment to decrease. Negative interest rates, however, have potential downsides. One major issue is the potential to cause asset bubbles as banks are incentivized to take excessive risks. According to Keynes’s General Theory negative interest rates will not increase employment if propensity to consume is decreasing. Negative interest rates are not the answer, but the refined approach that the Fed is taking toward inflation should help increase investment and employment
    https://www.thebalance.com/current-federal-reserve-interest-rates-4770718
    https://www.bea.gov/system/files/2019-11/gdp3q19_2nd.pdf
    https://www.cnbc.com/2020/08/27/powell-announces-new-fed-approach-to-inflation-that-could-keep-rates-lower-for-longer.html
    https://www.theguardian.com/business/2016/may/25/negative-interest-rates-the-case-against-john-maynard-keynes
    https://www.bea.gov/sites/default/files/2020-10/gdp3q20_adv.pdf
    https://fred.stlouisfed.org/series/UNRATE#0
    https://fred.stlouisfed.org/series/GDPPOT#0

  34. Yes, but on a limited basis. The central bank’s control is limited to short term interest rates and the federal funds. Overall, long term interest rates controlled by commercial banks are what affect the economy. For the economy, common consensus is that the monetary policy needs to change in light of the COVID-19 recession. The Wall Street Journal mentioned that as a result of Federal Reserve’s push towards lowering interest rates, the Reserve has fewer resources (i.e. cash funds) to aid in the recovery. In fact, multiple sources (Fox, NY Times, Washington Post) mentioned that it could take half a decade for the U.S. economy to return to pre-pandemic levels. Part of that goes to political pressure on the federal reserve by President Trump. For much of his presidency, Trump presided over a booming economy and wanted to keep it that way. This was done by pressuring the Federal Reserve to keep interest rates as low as possible (i.e. focuses more on the short term than the long term).

  35. The central bank of the United States, aka the Fed, conducts monetary policy to stabilize prices, achieve maximum employment, and strengthen the financial system (1). When the Coronavirus hit the United States in March, the U.S. Economy entered a crisis. The Fed responded to this event by cutting interest rates by one and a half percentage points and pledged to keep them low for the next three years to reduce the damage of the pandemic on the economy and support a strong recovery (2).
    Today, the economy is slowly recovering from the impact of the virus (3). The rates are near zero, and the Fed cannot lower them any further without going negative. Negative interest rates will push banks to lend more money to borrowers. Borrowers will invest and spend more money, which will stimulate the economy (4).
    Although this might be a good tool to stimulate the economy and encourage investment in theory, the Fed should not consider using it. Negative interest rates will harm the economy because banks will lend less money to borrowers and consumers will take the money out of the financial system. Banks will be discouraged from lending money to borrowers because negative rates would reduce their profits. People will take money out of their bank accounts because they will be charged for not investing it. All of this will reduce money supply, which will increase interest rates drastically, which will harm the economy even more.
    (1) https://www.federalreserve.gov/aboutthefed.htm
    (2) https://www.stlouisfed.org/open-vault/2020/august/fed-response-covid19-pandemic
    (3) https://www.marketwatch.com/story/second-quarter-us-gdp-left-at-2-downshifting-economy-unlikely-to-rev-up-soon-2019-09-26
    (4) https://www.youtube.com/watch?v=6KibetJGVA0

  36. One of the Federal Reserve’s most notable tools to help an economy through monetary policy is its control over the interest rate channel. It is almost certain that the Federal Reserve (the Fed) can affect the economy through the interest rate channel. (1) The question then comes down to how big that effect is. Some research says there is a noticeable effect, some says there isn’t, and instead other factors influence investment. (2,3) However, the effect of interest rates on consumer consumption is more influential, although this sectoral influence has been less studied. Yet, there is a reason the Fed is pushing down rates so low.
    Even though it seems inconclusive as to how much the control of the interest rate channel by the Fed impacts the economy, there is still an effect, which is why rates by the Fed have been pushed so low in response to the COVID-19 Pandemic. The Fed can do much more, and has done much more in this pandemic, but the interest rate is their foremost tool. (6)
    For the Fed, they believe that economic recovery from this pandemic will take time to fully materialize, even if there are signs already showing. That is why they have taken such drastic action, changing the way they evaluate inflation. (4) In theory, these low rates should buoy investment, despite the harsh economic conditions. This is already being seen with record home sales during the pandemic, which is partially aided by the fact that mortgage rates are so low. (7)
    Then that begs the question, why hasn’t the Federal Reserve pushed rates to negative levels. On paper, negative rates seem very attractive as a way to induce a demand shock into the economy. (5) The theory goes that if rates are negative, it will force people holding money in savings accounts to spend their money, lest they lose value on it. It has been implemented in places like Japan and the European Union. Still, it must be noted that those negative interest rates were implemented in a generally post-recessionary period, while this proposal for the Fed to do the same comes in a period of great economic crisis. The full implications of negative interest rates are not known, and to implement them could have disastrous consequences on the US economy. (5) That is the likely reason why the Federal Reserve has not fully pushed down interest rates into negative territory.

    1)https://www.newyorkfed.org/aboutthefed/fedpoint/fed32.html
    2)https://www.nber.org/system/files/working_papers/w5464/w5464.pdf
    3)https://www.federalreserve.gov/pubs/feds/2014/201402/201402pap.pdf
    4)https://www.wsj.com/articles/fed-signals-interest-rates-to-stay-near-zero-through-2023-11600279214#:~:text=The%20Federal%20Reserve%20expects%20to,recovery%20from%20the%20coronavirus%20pandemic.
    5)https://www.bloomberg.com/quicktake/negative-interest-rates
    6)https://www.brookings.edu/research/fed-response-to-covid19/
    7)https://www.npr.org/2020/08/28/906725372/more-space-please-home-sales-booming-despite-pandemic-recession

  37. The idea is that when a central bank lowers the interest rate, in the short run real interest rate is also lower which increases investment and household spending which will stimulate the economy. That’s why it is used during economic downturns. However, the interest rate is almost zero now. How low can it go? We must understand that it is not zero interest rate that gets the economy out of recession but lowering interest rate than it previously was and that creates a shock. If investment level and spending are adjusted to 0 interest rate because low-interest-rate has been around years, how are we going to create a shock next time? We can bring a negative interest rate, but it can’t go much low because it’s not that banks have a negative rate but just the fees make it negative when there is no interest. Plus, I think people would rather keep their money under the mattress if there were negative interest rates. We can increase the money supply to lower the real interest rate but that means we must assume that increasing money supply, increases inflation. That’s is not happening. In general, some areas of the economy’s interest rate did not have the effect as it supposed to have. Like there is not much correlation between the mortgage rate and housing price. It is hard to tell if the theory is flawed or there is a greater force that is dictating the direction. I do not believe the interest rate will have much effect on stimulating the economy now. Recently, the fed chair main said fed is willing to hold interest rate low for some period and willing to have an increased rate of inflation. I thought they are planning to lower the real interest rate through inflation but there are two problems. 1) we have not seen rising inflation and we can’t be sure the central bank can achieve it. 2) we must think about why the U.S. dollar behaves differently than other currencies. If we increase the money supply and increase the inflation rate, there might be a possibility that the U.S. dollar losses its title as a reserve currency which I think is an enormous economic privilege even when we consider the higher exchange rate lowers export.

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