Monday, February 28, 2011

The Federal Reserve, Monetary Policy, and Oil

Over the next few weeks we will begin discussing the role of the financial system and in particular the role of the Federal Reserve. In short, the Federal Reserve lowers interest rates when the economy is slow and raises interest rates when the economy is fast. Today they have set interest rates very low and would like to keep rates low until the economy fully recovers. Unfortunately there is a large constraint on their ability to keep interest rates low, inflation. When the Fed lowers interest rates, it gives us more money for loans, which results in more inflation. So lower interest rates lead to higher inflation, and when inflation starts to increase they raise interest rates.

Right now is an unique period. Interest rates are low, and have been for three years, but inflation is also very low (around 1%). Unfortunately oil could ultimately force the Fed's hand. The results could potential start a second recession. Low interest rates makes it cheap to borrow money (we like cheap money), if the Fed is forced to raise interest rates investment will slow down and it will get much more costly to borrow money. Here's a good article explaining everything.

1 comment:

  1. These things really make the market move in big way, so if we are to be successful we must take notice of all these. I am working with OctaFX broker where they provide me all these news and updates for free with their daily market analysis service, it is absolutely free yet highly accurate, so that’s why for new comers like me it’s just picture perfect and consistently following this will bring good profits, but we do need to have strict money management in place.