The recent trends in the US economy indicated that it is slowing down (in economic terms, stagnating). The widening trade deficit with China is forcing many companies to transfer a significant portion of their capital to China (which offers a huge market for American goods).Added to that, the unexpected decrease in retail sales just a couple of weeks ago forced the government to issue temporary bonds to reinvigorate the industry. The unexpected point drop in the said industry was “supplemented” by the devaluation of the US dollar against the Euro.
Many economists think that the US economy is experiencing what Japan experienced 10 years ago: a receding economy.This situation of the US economy can be partially explained by analyzing the movement of interest rates in the country. There are generally two types of interest rates: short and long-term interest rates. Short-term interest rate is the interest rate charged for short-term loans. Long-term interest rate is the interest rate charged for long-tern loans as determined by the Federal Reserve Board. The Board determines the volume of money circulating in the economy.
In a simple relationship, high interest rates motivate lenders to put more money in bank. Investors though borrowing from financial institutions are forced to delay their borrowing schedule. In short, there is an inverse relationship between interest rate and investment. Investment is represented by (I), the amount transformed into capital. Interest rate is represented by (r), determined by the volume of money circulating in the economy.
Short-term interest rates are more fluid than long-term interest rates. A slight change in the volume of money in the economy results in a greater change in the interest rate schedule of banks (for short-term loans).Long-term interest rates are usually static in the short-run. Effects can be perceived after a series of interest rate restructuring is implemented.
Usually, the government announces a decrease or increase in the interest rate in order to give financial institutions time to adjust their interest rates. Hence, the government is responsible for fixing the monetary policy of the country (in this case, the US).How is interest rate related to the volume of money? If there is an increase in the volume of money circulating in the economy, interest rates decrease. Banks are less willing to increase the savings deposits of potential depositors. If the volume of money decreased, banks are more willing to lend investors capital.
Note that the relationship is also inverse (this is an extension of the I and r relationship).ReferenceFederal Reserve Bank of New York. (2007). Retrieve on October 21, 2007 from http:// http://www.ny.frb.org/.
