US Interest Rates

Abstract

Interest rates are one of the tools that Central Banks use to regulate economic activities within an economy. In the US, the FED is solely charged with the duty of determining some rates of interest in the country. If FED rises of reduces the rate of interest, bank consequently raise or lower the interest that they charge borrowers. Over the years, the rates of interest I the US has been fluctuating constantly due to several factors. Between 1970 and 1980, the interest rates recorded as per that time were high according to predictions that had been made by the financial analysts in this field as opposed to previous records. However, the rate has been going down over the years, reaching a low of 0.25% in 2011. Currently, the rate is at 3.25%. The future rates of interest in the US might not be easily predictable due the changing economic activities in the world. However, going by the current situations it is highly likely that the rates of interest will go down significantly.

Interest fluctuations over the years

According to the latest research on interest rates, frequent and close focus has been done on the structure of the interest rates whose focus is on the interest rates and channels that project the economy’s expectations. This structure analyzes the relationship that exists between interest rates and the different instruments of maturity. Moreover, the structure of interest rates is also frequently used to examine the effects associated with monetary policies whose key objective is to ensure that there is price stability, which facilitates growth of an economy.

The central bank of the United States is responsible of controlling the interest rates in the country, for instance the bank can reduce interest rates when the nation wishes to increase investment and the country’s consumption (Gasha et al., 2010). Nevertheless, in controlling the present interest rates there are measures that must be carefully considered to avoid economic constraints.

Before the establishment of the Federal Reserve System, the short-term interest rates ordinarily exceeded the long-term interest rates in this period. In addition, no theoretical analysis or historically observed patterns of interest rate behavior can really account for this occurrence. Historically, apart from the risk aversion, the expectations suggest both increasing and decreasing yield curves, which have equal probability. Records indicate that the United States interest rate levels once fell drastically in the 1890’s but then started rising slowly in 1914. Due to unavailability of trustworthy data, estimates were formulated for the years 1884 through to 1899 whereby the first quarter average yields were calculated from the prevailing market prices of high grade bonds and yield curves that were generated by least squares estimation (Medeiros & Waldo, 2011).

It is important to note that the early interest rates quoted here were unpredictable money market rates of interest because a fluctuating money economy existed in those ancient times (Gasha et al., 2010). In such kind of an economy, daily bargaining among merchants and traders for credit at a price existed. In addition, up to recently the American interest rates fluctuated very sluggishly whereby a 6 percent tradition lasted for at least two centuries. Moreover, usury limits generally lasted for a long time untouched until in the 1960s when the bank loan rates were removed from money market centers and from big businesses that were relatively stable for a long period (Medeiros & Waldo, 2011). Some of the judgments done by the Board include changes in discount rates, which depend on the recommendations presented by one or more regional Federal Reserve Banks. Likewise, the Federal Open Market Committee makes decisions that pertain to open market operations, including the desired levels of central bank money or the desired federal funds market rate.

Some of the factors influencing the United States interest rates currently include the inflationary expectations (Medeiros & Waldo, 2011). One of the serious impacts of inflation experienced was by the American private sector where private pension plans accumulated surpluses of billions of dollars. Stopping inflation can be very expensive to a country and could as well reduce the output and increase the rate of unemployment in an economy hence, changing the economy depending on how it reacts to the inflation. Another one is the existence of short-term political gain, which involves lowering interest rates with an expectation that this will be settled by inflation but the United States economy supports independence of their central bank to avoid such happenings (Gasha et al., 2010). The risk of investment is also affecting the present interest rates in America since banking or the lending institutions will always have a fear that the borrower may die and so fail to repay the loan. This therefore results into increase in the interest rates to cater for such losses that may occur from such cases (Homer & Syla, 2005).

Theories on the future expectation of the United States interest rates state that long-term interest rates constitute of an average of the future short-term rates. The United States future short-term rates are expected to decrease because the current short-term rates are higher than the current long-term rates in the economy. Consequently, this economy also expects to witness rise in the future short-term interest rates because of the prevailing short-term rates, which are high, compared to the present long-term rates (Homer & Syla, 2005). Assuming that default risks will not be in the economy, it is expected that the United States rates of return expected from holding securities of maturity over a particular period will be the same. As a result, either more expectations are on the yield curves that may be positively or negatively sloped, or horizontal depending on whether the expectations of the market will rise, fall, or remain constant in the future short-term interest rates. However, projections indicate that the economy will experience a similar move in the direction of both long and short-term interest rates. Nevertheless, there is an anticipation that the short-term rates will fluctuate wider than the long-term rates.

References

Gasha, G., et al. (2010). On the Estimation of Term Structure Models and an Application to the United States. Washington DC: International Monetary Fund.

Homer, S. & Syla, R. (2005). A History of Interest Rates. New York: John Wiley & Sons.

Medeiros, C. I., & Waldo, M. R. (2011). The Dynamics of the Term Structure of Interest Rates in the United States in the Light of the Financial Crisis of 2007-10. Washington DC: International Monetary Fund.

Rudebusch, G. R. and Wu, T. (2008). A Micro-Finance Model of the Term Structure, Monetary Policy and the Economy. The Economic Journal, 118 906-926.

Walsh, C. E. (2010). Monetary Theory and Policy. Cambridge, Massachusetts: The MIT Press.