Regulating Interest Rates in the Money and Capital Markets - Essay Example

When the economy falls into recession or deflation, Fed normally cuts the interest rates and takes suitable policies to maintain the low-interest rates. The intention is to give incentives to people and businesses to borrow and spend more and thus sustain the economy. But when the economy shows signs of inflation and fast economic growth, Fed will raise the interest rates and keep high-interest rates. This will cause the borrowing to become costlier and lead to slow spending and economic growth.

The Present Situation

Here the situation needs special attention from policymakers as the economy shows signs of deflation in some districts and inflationary trends in other districts. The states of New York and San Francisco districts show the trends of price deflation while all other districts believe that inflation may be at hand. The groups of policymakers as well as media who fear the future outbreak of inflation believe that the Fed’s decision to keep interest rates near zero and pump the economy with credits will lead to the spread of inflation in the near future.

But among the policymakers of the Fed, a substantial wing believes that the already low rate of inflation will again be slow due to the unsolved real estate problems in the majority of the districts. It can be pointed out that the dwindling rate of inflation is evidence of the excess capacity and the need to sustain the economy with lower interest rates.

Inflation is always dangerous, but deflation is more dangerous. Hence, Fed’s decision whether to keep the lower interest rate so as to widen the spending or to increase the interest rate in order to tighten the economy is a crucial question at this stage. Though there are some trends of inflation Fed will decide to keep the lower interest and loosen the monetary policy.

The continued low rate of inflation has strengthened the hands of officials in the Federal Reserve who are in the believe that there should not be tightened monetary policy.

The recent meeting of the Fed has decided to follow the lower interest rate as there is no fear of inflation in the near future.

(http://articles.latimes.com/2010/apr/07/business/la-fi-fed-dissent7-2010apr07).

Hence in this present situation, it is better to keep the lower interest rate and raise the short-term interest rate whenever the situation arises. At present inflation cannot be seen as an immediate threat to the economy, instead, soft inflation will boost the economy. Read More