Companies suddenly notice that profits are lower than hoped for. New investments do not pay off, contrary to expectations-they “flop.” Projects are halted, ventures are liquidated, and jobs created during the boom are lost. When interest rates rise, people reduce their consumption and save more of their current income. What happens when the central bank raises interest rates is obvious in light of what has been said. Returns on many business investments lag behind the rise in debt, contributing to the increase in overall debt. Consumer spending is financed “on tick,” which essentially means capital consumption and no capital accumulation, and the government, in particular, which normally contributes little to nothing to the economy’s productivity growth, borrows heavily to finance its spending. The investment success, and thus the continuation of the boom, depends on interest rates remaining low or falling to even lower levels.Īs long as the boom continues, everything seems to be working fine and properly. Companies seem to be doing everything right: they are making profits, borrowing is possible without major problems, workers can hope for higher wages and more job opportunities, tax revenues flow, and stock market prices climb to new highs.īut debt is also growing in absolute terms and in relation to economic output. The boom has an impact on the economic production and employment structure: scarce resources are increasingly being invested in long-term, time-consuming projects and less in the production of consumer goods. The artificial suppression of interest rates initially causes an economic upswing, a boom. Such an artificial supply of credit lowers the market interest rate below what it otherwise would have been. It amounts to creating money out of thin air. The interest rate is extremely important to the fiat money system because central banks create fiat money in close cooperation with commercial banks, which lend money to consumers, producers, and governments without corresponding savings funds (renunciation of consumption). In the fiat money system, interest rates are not established in a “free market.” Rather, the interest rate is determined in a “restricted market.” Not only do central banks dictate the short-term interest rate, but they now also have a firm grip on the long-term interest rate through the purchase of debt securities in principle, they can determine the interest rate to the decimal place. The answer begins with a look at the fiat money system that is ubiquitous today. Even the ponderous European Central Bank (ECB) now plans to raise interest rates at the beginning of the third quarter.ĭoes all this mean that there will be an “interest rate reversal”? Many other central banks have also reacted-such as the Bank of England, the Central Bank of Australia, and the Central Bank of Sweden. The US Federal Reserve (Fed) has raised its key interest rate to 1 percentage point. Public displeasure at the increasing currency devaluation has now forced monetary policy makers to act. The crushing issue of high inflation caused by central banks can no longer be downplayed. In a statement on Wednesday, the Fed said that though unemployment has declined significantly, inflation has remained elevated, "reflecting supply and demand imbalances related to the pandemic, higher energy prices, and broader price pressures," as well as the ongoing invasion of Ukraine and COVID lockdowns in China.The crushing issue of high inflation caused by central banks can no longer be downplayed… Read more: Pressure Mounts on Fed as Inflation Reaches Highest Rate Since 1981Īt that time, the Fed indicated that it expected to approve a half-dozen more increases throughout 2022.
Typically, the Fed increases interest rates in increments of 0.25%, as it did in March, its first bump since the pandemic started. Voting members of the Federal Open Market Committee voted unanimously for the increase, the largest hike since May 2000. The central bank said the move, along with plans to decrease its $9 trillion in holdings, will raise the target range for the federal funds rate to between 0.75% and 1%. The Federal Reserve approved an interest rate increase of a half percentage point on Wednesday in hopes of taming runaway inflation, its most aggressive increase in two decades.
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