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What Happens When the Fed Lowers Lending Rates?

September 19th, 2007 · No Comments

Ben Bernanke took out his wallet and lowered the key interest rate by a full half point. When the Fed lowers prime rate, market become uppity. Think of it as everyone getting their loans cheaper from the government. Banks can now borrow money from the Federal Reserve at 4.75% interest. This discount will make its way through all the financial markets. Big firms, and investors in the stock market and other financial indices will borrow money, expecting their investments to appreciate in value, thereby generating profits. The whole idea behind the Fed controlling interest rates has been that the unemployment has to be kept low, as also the inflation. For the first time in many years, the US market was showing a downward trend in employment rates; also, the sub-prime mortgage crisis has meant that borrowers have had to live in a very cautious market.

If less money is available on the market, economic growth will stumble. These are the reasons why Ben Bernanke pushed for lowering the interest rate. Ben is quite accomplished, with his being an expert in the study of the Great Depression. In fact, two rates have been lowered, the Federal Funds Rate and the Discount Rate. The former is the rate at which banks lend each other money. With a lowering of the fed rate, low rate mortgages are possible, and so this would be a good time to try and refinance your mortgage. A direct result of the fed lowering the rates should be a decrease in the Prime Lending Rates of various banks. Of course, they need not be the same across all banks, but overall, there should be a decrease in the rates of loans offered by lenders. If the rate falls too low, however, you will soon have “too much money chasing too few goods”, and everyone will realize they can charge more for their products and services – leading to inflation. So that’s why a half-percent fall in the interest rate is significant. Everyone was expecting the cut to be a quarter-percent. Let’s hope Ben got it just right, and that this cut should get the markets on track, and everyone employed :)