interest rates in central banks

unclebutcher SG

for those who have done macro, why when the US Fed Reserve cut its interest rates then all the stocks went up? what is the implication of an interest rate cut/ rise?

US is 4.75%, 4.75% is deposit or lending from banks to people?

How about MAS' Interest rate?? i heard its low...

and whassup with the Bank Of Japan's almost 0% interest rate? what are they trying to do?

not anything related to hw, just preparing for next yr econs. Wink

eagle SG

i forgot a lot... 6 yrs ago liao

1) read up of fiscal policy and monetary policy for greater understanding
2) Interest rate down, propensity to save decrease, propensity to loan increase. Thus, spending increase. Increase amount is not same as amount extra that was spent; there's still the multiplier effect

Something like that I think

Paradise Lost SG

I guess you have been actively following the papers regarding the sub-prime mortgage defaults leading to a full-blown credit crunch with far reaching repercussions across asia and the whole world, leading to an initial cut in the "Federal Discount Rate" and followed by a cut in the "Federal Interest Rate" or "Federal Funds Rate" by 50 basis points (0.50%).

In this case, your question is referring to the "Federal Funds Rate".

Before answering that question, you have to understand the point whereby banks have to place a certain amount of funds with the central bank in order to meet the banking regulatory requirements of the country. The Federal Funds Rate is therefore the interest rate at which the Feds allow its member banks (consisting of the US's depositary institutions) to make overnight loans to each other, using the reserve that they initially placed with the Feds.

A cut or rise in the Federal Funds Rate determines the monetary policy that the Feds implement and subsequently the entire economical outlook of the USA. In this case, a cut in the Federal Funds Rate stimulates more inter-bank borrowing as the interest rate is lower and leads to increase in liquidity to make for investments. In view of the recent sub prime mortgage fallout, it also serves to mitigate the credit crunch facing the US interbank loans market as there is currently an "adverse selection" scenario playing out where banks are adverse to making loans to one another for fear that the respective parties have sub-prime mortgage defaults that may undermine the loans.

Likewise, a cut in the Federal Funds Rate is all fine and dandy as it stimulates economical growth but the Feds risk pushing the economy into overdrive if the interest rate is left unchecked. A repercussion of an overdriven, overheating economy would be Inflation, whereby the real price of assets, equities, commodities, property and even living expenses get "artificially" pushed up. This can be a real problem as inflation will undermine the average consumers average propensity to consume as their disposable income decreases and limits the amount of foreign investments, leading to a drop economical growth the GDP.

As government economist, it would therefore be in the Fed's best interest to maintain the tricky balancing act of stimulating growth and reigning in inflation at the same time through the tweaking of the Federal Funds Rate.

Paradise Lost SG

Please refer to previous post.

If your referring to the Singapore equivalent of the Federal Funds Rate, im afraid that isn't a good comparison as the MAS adjusts our domestic monetary policy not by tweaking the interest rates but by trading/speculation via the foreign exchange mechanism in the Singapore dollar market.

Our government basically keeps a basket of different foreign currencies, including the Singapore dollar as well. Through the manipulation of this basket of currencies, with the proper magnitude backed by our monetary reserve, the MAS is able to control the Singapore dollar's exchange rate and subsequently influences the domestic money market liquidity and monetary policy of Singapore.

Anything that is remotely identical to the Federal Funds Rate from our local perspective would be the SIBOR or Singapore Interbank Offered Rate, whereby it is a rate which banks loans unsecured funding to each other at a market-determined rate.
Note: Unlike the US context, the loan process is obtained from the bank's own balance sheet and NOT undertaken from the banking reserve requirement that the banks place with the MAS.

Paradise Lost SG

Theres lots of literature regarding the BOJ's obscenely ultra low interest rate widely available on the net and I won't dwell with its technicalities and historical evaluation to bore you to death.

In a nutshell:
What do you think is the main business of the Japanese? Theirs is a predominantly export driven economy and Japan exports a huge fraction of the world's supply of foreign goods to the rest of the world. Think in terms of your SONY, PANASONIC, TOYOTA, HONDA etc etc. Therefore, in order to propel your main source of business, you have to keep your costs low, otherwise foreign investors are going to find other sources of cheaper alternatives (think China).

A manipulation of the BOJ's interest rate to an obscenely low rate keeps the costs of borrowing the Yen cheap, encouraging foreign investment and keeping export costs low, not forgetting various political agendas has influenced the rate to reach a near 0% level.

Problems with these cheap and seemingly never-ending supply of Yen from Japan? You bet. Foreign investors borrow the Yen, at the low low rate provided, and invest it into higher yielding equities around the world for larger returns and fatter margins and their borrowing at the rate of billions. Most of the assets and equity prices that we see nowadays are therefore driven up and speculated on by these infamous "Yen carry trades". A 0.50% point hike by the BOJ is enough for a mega institutional investor to rack up huge drops in profit whom leverages on these Yen carry trades ( Loss of profit = 1,000,000,000 X 0.5 ). As many factors (political, domestic, macroeconomical etc) can undermine the BOJ's decision to hike the interest rates, economist predict that the "unwinding" of these huge Yen carry trades will be the catalyst of a major financial meltdown on a global scale.