Let me see if I can explain this in a clear manner - and if someone disagrees they can jump in.
A function of CBs is to control economic growth so that it grows at optimum rate without inflation. In countries like Germany, they target money supply as a means to regulate inflation while others like the US target interest rates. That is the Fed lowers or raises rates depending on what it expects of the economy and rate of inflation and thereby encouraging or discouraging borrowing or expansion of credit.
Currently this interest rate called the Federal Funds Rate is at 5.50 percent. One way to measure whether this rate is too high or too low is to compare it with inflation as measured by the CPI. If it is above the CPI, then it is restrictive as it considered to curtail growth. This difference called the Real Funds Rate, defined as Fed Funds Rate rate minus yearly change in CPI , is at 3.5%.
The Fed Funds rate has not been modified by the Fed for sometime. Some, and apparently the Fed itself, deem it mildly restrictive and appropriate in view of the current strength in the economy when considering the strong housing starts, consumer spending, high employment, wage increases, and continued GDP growth among others.
Others claim it is too high and point to global deflationary trends and recessionary indicators such as the steep drop in gold and the inverted yield curve (which reflects that bond holders expect a lower rate of inflation than the Fed itself and, if not corrected, according to certain economic models, forecasts a recession about a year in advance)
I know of nothing that prevents the Fed from raising or lowering the Federal Funds rate. As mentioned, it may be currently apprehensive of doing so because of the strong economy and its concern that a lowering of rates would add to cyclical inflationary pressures within the economy. Rather, it seems to be waiting to obtain a clearer picture as to which force, deflationary or inflationary, will be dominant in the time ahead. If the stock market were to crash, this would probably be deemed a contractionary influence on the economy and it is then likely that the Fed would quickly reduce rates, as it has done in the past, to soften the fall and hopefully prevent deflation, The lowering of rates of course would also induce a flow of money into stocks. |
