I found an interenting interview conducted by Minneapolis Fed with Robert Hall, a prominent economist. Setting all aside, the important point raised by him on the topic 'Financial Frictions' regarding interest rate rigidity deserve compelling to me. He says:
There’s been no systematic decline in those interest rates (interest rates faced by private decision-makers (added)), especially those that control home building, purchases of cars and other consumer durables, and business investment. So although government interest rates for claims like Treasury notes fell quite a bit during the crisis, the same is not true for private interest rates.Between those rates is some kind of friction, and what this means is that even though the Fed has driven the interest rate that it controls to zero, it hasn’t had that much effect on reducing borrowing costs to individuals and businesses. The result is it hasn’t transmitted the stimulus to where stimulus is needed, namely, private spending.
According to him, interest ridigidy could be one of possible explanations to explain business cycles. As such, the Fed has challenge as to how the target on federal funds rates can be effectively transmitted to rates charged on private loans such as credit card loans, consumable loads, etc. with less time lag and full effect. Generally we don't observe any reduction in our everyday interest rates immediately after we hear the news that Fed has reduced interest rates. Where's the channel missing?
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Although the Fed may reduce the interest rates for banks, the banks are not passing down the new low interest rates on the consumers to increase their profits. Since the consumers’ interest payments to banks are their primary sources of income, there is a reluctance to decrease those payments, even though the banks themselves are now paying less to borrow themselves. Other reason for not lowering the consumers’ interest rates is that in general, the rates will go back up, and most consumers are not very receptive to having their finance charges increased, even though they were lower previously. Finally, the banks are not decreasing the interest rates to differentiate between different types of borrowing. For instance, mortgages have traditionally the lowest interest rates out of any consumer loans, because they are the most difficult to acquire, and have a very lucrative collateral that could be foreclosed in the event of default. There is also a strong practical and emotional attachment of the borrower to the home, so that mortgage payments are most likely to be made on time and in full. Next, the auto loans still have a good collateral, and some of the same practical and emotional attachment from the borrower that helps keep the loan in good standing. Finally, credit cards and other personal loans with high interest rates guarantee the bank at least some profit when the borrower (quite often) defaults or makes a late payment. Reducing the interest rates for borrowers by banks across the board will reduce the banks’ income, and although it may stimulate consumption, it will also result in more risky and careless borrowing.
ReplyDeleteRenell Anderson
ReplyDeletePre-crisis and historic everyday interest rate reaction to federal fund rate reductions has been non to slow upward movement. It has occurred often in the past that a reduction of the federal fund rate increases money in the economy which most often has contributed to increased inflation which has resulted in the increase of interest rates that everyday citizens have to pay.
While it was crucial that the federal rate be reduced to support the restoration of interbank lending along with the other tools that have been used during this crisis, far too little has been done to help correct other crisis generated troubles.
It is my opinion that until the following conditions to name a few have been thoroughly addressed the quality of American life that has been experienced by so many for so many years will continue to disappear for many an may never return or be experience at all by others:
1) Consideration of how person debt exposure (personal bailouts) can be minimized.
2) Unemployment rate reduction
3) Restoration of confidence about the nation’s long term economic health
The same misguided ingenuity that contributed to the creation of the crisis should possibly be modified in more philanthropically ways with far more consideration for the welfare of the larger percentage of the population. This action must deviate significantly from past policies which have historically been similar to what was once called Reganomics, (trickle down theory) which proposed that if the wealthy are looked out for first the majority of the remaining citizenry will be alright too.
Avadella White
ReplyDeleteI find this issue of interest rigidity very interesting and a major problem for economic recovery. It was mentioned in the interview that financial institutions have not been willing to lower the interest rates for “private decision-makers” except in the area of housing. I found that they were not willing to reduce interest rates in many cases even in housing. Government programs (not banks) such as those for first time home buyers filtered down to the consumer but many banks were unwilling to lower their interest rates for homeowners in financial trouble and help stimulate the economy. While listening to National Public Radio, I heard a bank representative say that they were against refinancing to lower interest rates because the people who could afford to pay the higher interest rate would benefit and those that could not would default on their loans anyway so basically, why bother. Many of these banks were given millions of dollars to stimulate and strengthen their businesses. This whole issue of financial institutions refusing to lower interest rates to assist in stimulating the economy seems to reflect a principle-agent problem. It appears that the behavior of the agents of many financial institutions has been self-serving. They are making financial decisions with a short-term view of the problem that will provide the biggest gain for them personally. Their moral hazard behavior demonstrates that they are taking full advantage of the belief that financial institutions are ‘too big to fail.’ They are operating under the premise that the government (taxpayers) will bail them out if they run out of capital. It seems regulators once again need to step in to address this problem.
“So although government interest rates for claims like Treasury notes fell quite a bit during the crisis, the same is not true for private interest rates. Between those rates is some kind of friction, and what this means is that even though the Fed has driven the interest rate that it controls to zero, it hasn’t had that much effect on reducing borrowing costs to individuals and businesses.”
ReplyDeleteI completely agree with Robert Hall’s observations that consumers have not experienced a decline in borrowing costs. Low rates passed down from the Fed never entirely reach private individuals; banks absorb the majority of the decreased costs as additional profits and consumers experience rather rigid interest rates. There is a fundamental problem in the way in which the Federal Reserve attempts to alter rates charged to consumers. Since they are essentially removed from the determination of final interest rates, their policy, as well as the rates they charge banks have little effect on consumers. I believe the missing channel is additional regulation that reigns in the bank’s ability to inflate consumer’s interest rates. Much in the way usury laws protect consumers from unreasonable rates, I believe there should be regulation regarding the banks use of federal funds. As the Federal Reserve reduces borrowing costs for banks, the banks should be required to pass a portion of the savings down to consumers. This should not only help the Federal Reserve increase the effectiveness of policy, but should also help the banks sell more loans as the demand increases.
-Matthew Moore
The way I am looking at it I can see both sides of the argument. If the fed controlled interest rate has been driven down to zero, shouldn’t it be the same for private interest rates. The answer to that depends on the situation of the economy. The Fed has the control over the money supply which effects employment and interest rates. The lowering of their interest rates make them heavily favored for loans which helps stimulate their operations.
ReplyDeleteTheir control over money supply and to moderate the economic climate can afford them the decision of lowering interest rates. The interest rates of private decision makers have not declined as they are trying to recover from the loss of the subprime mortgage financial crisis among other financial crisis that occurred a few years ago eg : dot.com bubble burst, Enron, Bernie Madoff’s ponzie scam and a list of others .
As a consumer you may not be able to understand why the feds are lowering interest rates while private institutions are not. But you must take into consideration the financial conditions of both organizations. These private institutions do not have control of the money supply. They do not have the power to create money to increase or leverage their position. In this prospective they are relying on the interest rate to inject prosperity into their operation which at this point they do not have the leg room to decrease to the extent of the fed.
Petrica Molnar:
ReplyDeletewow so the banks are scamming people for profits yet again!! Banks are now taking large loans from the FED at zero percent inerest and making loans to the public at high interest rates and making large profits. So, do we blame the banks, the FED or anybody for that matter? The FED is trying to give the bank incentive to make low interest loans by charging them low interest and federal reserve loams. The bank in turn are using this as profit opportunity. We canf blame the banks because they are private institutions looking to make profit, and unless mandated will not act in any other way.At the same time we don't quite know what the intentions of the Fed are exactly. By lowering interest rates they increase money supply and temporarely decrease unemployment which is ultimetly a plus. At the same time you can see the FED being upset, as they back the banks up in all things and want the people to trust them,and yet the banks continue to show that they are not intrested in the people, but rather in profits. So you can understand both sides of the story.
I believe that interest rate rigidity on consumption goods other than housing is a good predictor of spending and saving decisions of the consumer. Recent history suggests that spending habits and consumer confidence are highly correlated with interest rates. As credit is currently more expensive for durable goods suggests that banks are hoarding or rationing their credit supply. Because financial institutions still hold toxic assets on their balance sheets and are moving away from risk aversion, they will continue to lend money at a much higher rate than the FFR. Furthermore, Interest rate rigidity will fluctuate with current policymaking decisions and future expectations of money market interest rates. Finally, banks can ultimately exercise market power when it determines the cost of borrowing of money.
ReplyDeleteBrian Frisch
"Financial frictions" means creditors are less willing to lend (or lend at higher rates), because their fears of not being repaid had gone up.
ReplyDeleteCommercial Banks always have higher interest rates for risker borrowers, but as the number of the defaults by risker (sub-prime) and prime borrowers increased, banks have steadily increased the overall interest rates. This increased the spread between the average interest rates charged by banks to the borrowers and the average interest rates paid by the banks to Federal Reserve to fund these loans.
The Federal funds rate and Federal discount rates are short term loans that are offered to the financial institutions (nightly to Annual), whose rates are less than 0.5%.The yields on the 30-year and 10 year treasury notes are used to set long-term residential (30 years and 15 years) mortgage interest rates. The current yields on the 30-year and 10 year are 4 and 3.25%.
The loans for the big ticket items such as houses and cars are long term loans and cannot be compared to annual federal funds rate.
ANTARA MAJUMDER
Though the Fefs are passing down the interest rates to Banks, the trust in the Banks isn't there so they can't directly pass down the saving to the consumers. Since this crisis is directly targeted to the Bankd, a lot of consumer trust has gone which has caused so mny people to take their money away from the banks. In this situation, the only way for the Banks to make their money is to be greedy and keep their saving to theirselves. It was a time that the banks would have had no problem in passing this savings along to the consumer and still maintain their economic profit but that time isn't now. As a consumer of course I would be upset that the banks aren't looking at my bes interest, however, in order to get back to a financially stable point the banks must practive this assymetrical holding in order to try to make a profit until consumer trust is back in place. Is it fair that consumers must have this information on savings withheld? No. But in order to recoup what they have lost and be able to maintain financially in the long run, the banks must look at their interest. Too manu people are deafulting on loans, liquidating their savings and all but left the bank, so the banks must maintain soemthing for themselves in order to offer help in the long run.
ReplyDelete-Alysia J. Sturges
As Robert Hall sees it and as I, a private consumer with my own interest related dealings to handle, strongly agree, there is a clear disconnect between Federal interest rate policy and the actual help the average American sees in their own interest rates on private loans such as credit card loans, consumable loads. The stimulus does not affect the public in the way in which it should. That is to say, the Fed driving down the FFR to zero does not correlate with a reduction in the private borrowing interest rates. Can the decrease of the Federal Funds Rate directly affect these interest rates in an observable way? To start, when the Federal Open Market Committee wishes to reduce interest rates they will increase the supply of money by buying government securities. When additional money supply is added and everything else remains constant, the interest rate ie cost of money, falls. By reducing the Fed Funds Rate, money is made cheaper, allowing an influx of credit in to the economy through all types of loans. However these loans and existing loans don't see a reduction in their own interest rates because the banks lending money to other institutions need to maximize profits in some way now that the interest rate for borrowing between institutions is bottoming out. The FOMC needs to look into direct stimulation of private borrowing.
ReplyDelete-Javier Janbieh
I do think that the federal govt should do a better job in regards to interest rates; in regards to this crisis that has hit this country so hard the federal govt should think about lowering its interest rates so that the citizens can keep more money in their pockets.
ReplyDeleteStacy