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Changes in Federal Reserve policy

Money and interest rates are important to individuals and businesses making decisions to finance purchases. The following articles assess conditions for finance purchases and important aspects of monetary policy.

Tom Woodruff has written an interesting and to-the-point article, "A borrower's guide to forecasting interest rates" about effects of the Federal Reserve's monetary policy and changes in interest rates.

1. Assume a friend you know needs a loan to make a large purchase (e.g. buying a new car, some business equipment, or a house). What major economic indicators would you suggest they examine?

2. Explain how the Federal Reserve's policy-makers influence interest rates including in your answer the difference between expansionary and contractionary policies.

3. How could changes in Federal Reserve policy affect your friend's decision to use financing to make a purchase?

Solution Preview

1. There are various factors that influence interest rates. In case someone is considering to make a large purchase it is likely that the person is going to go for a long term loan, and there it is very important to keep note of the interest you are going to pay over that period. A 1% difference in the interest rate on a loan of $100000 over a 10 year period will translate into a difference in payment of more than $10000! The question then is what factors should one look at to decide if the interest rate we are getting is a good one. Though there is no definitive answer there are some indicators one can use:

(a) Real GDP growth: if the GDP has been growing fast over some period of time, or has been in a recession that is coming to an end, then it is likely that the economy is facing inflationary pressures. This indicates that interest rates will rise in the future, and hence if one can lock in a low rate today it will be beneficial. For example, right now if you can lock in a 30 year mortgage at about 4-5% ...

Solution Summary

Changes in Federal Reserve policy are depicted.