[rgcounts]

Hi! I have two questions who’s answers are a little blurry to me:

1) Interest rate.. to what? I know all of this stuff about it and how it’s manipulated, but I don’t know what it’s an interest rate to. I assume it’s shorthand of some sort, for example: the Federal Reserve doesn’t actually “print” money, it accredits the Treasury Department, but it’s easier to say it prints money; so I suppose that people leave off what it’s an interest rate to, and everyone just knows what they’re talking about. So if I take a loan from a bank, the interest rate is to the loan. But what is the interest rate that everyone refers to with regards to the federal reserve? Where can I find information on it?

2) Absent the Federal Reserve, how would the interest rate be determined? The free market, yes, but where in the free market would it come from, and how would all of the different sectors of the economy follow the same interest rate?

Thanks for the time!

[aybartlett]

1)
http://en.wikipedia.org/wiki/Federal_funds_rate

The Fed does print money though.

“But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.”

Courtesy of Bernanke

Just because the newly printed money is parked right back at the Fed in “excess reserves” does not mean that money hasn’t been printed. Just see what happens if/when Bernanke decides to stop paying interest on excess reserves.

[jmherbener]

When the Fed buys things it either prints currency or writes checks on itself. Commercial banks can use either currency or checking account balances at the Fed as reserves against the deposits their customers have. Banks trade reserves over night. The interest rate on these loans is called the Federal Funds Rate. The Fed targets this rate when conducting monetary policy.

Here is information on the Federal Funds Rate:

http://www.newyorkfed.org/markets/omo/dmm/fedfundsdata.cfm

On the free market, the fundamental interest rate is determined by people’s time preference, i.e., their preference for sooner satisfaction instead of the same satisfaction later. Because of this preference, present money commands a premium over future money. People with less intense T.P. will lend to people with more intense T.P. and the fundamental rate of interest will be at the level that clears the market. In addition to the fundamental rate, the interest rate on each type of loan will have components to account for maturity, uncertainty, and changes in the purchasing power of money. For example: the 3-month, treasury bill rate will be lower than the 30-year, BBB rated corporate bond rate.

Here is some data on market interest rates:

http://research.stlouisfed.org/fred2/categories/22

[rgcounts]

Jeff,
Can you expand on this sentence?: ” Commercial banks can use either currency or checking account balances at the Fed as reserves against the deposits their customers have.”

You also said this: “and the fundamental rate of interest will be at the level that clears the market.” How does it clear the market?

[jmherbener]

The Fed regulates commercial banks. One of its regulations concerns reserves banks hold against their deposits. The Fed requires a bank to hold roughly 10 percent of the total that all of the bank’s customers have in their checking accounts at the bank. The Fed also dictates that banks can hold as reserves either Federal Reserve Notes (or currency) or checking account balances at the Fed.

Markets clear at the price at which the quantity of the good that buyers want to buy is the same as the quantity of the good that sellers want to sell. At higher prices there would be excess supply and at lower prices there would be excess demand. So each type of loan has an interest rate that clears the market, at which the quantity of credit borrowers want to borrow is the same as the quantity of credit lenders want to lend.

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