Interest rates of a nation depend upon the firmness of its economy and supply and demand of money in that country. Under normal economic parlance , if demand for the money in a country is on the higher side as compared to its supply , then , the interest rate will tend to increase and vice versa Thus , there are two principal drivers of interest rates namely government’s monetary policy and health of the economy of a nation. In U. S.
A, Federal Reserves, which is the central bank of America, is entrusted with the responsibility to keep the nation’s economy in good health, to keep the inflation at an arm’s length and to assist to create more employment. Under this postulation of banks not maintaining any surplus reserves and the requirement for currency are stable, then the deposit expansion multiplier factor is rather outsized and would remain steady, or foreseeable.
If the Fed could trust on the dependability or foregone conclusion of deposit growth arising from a shift in the monetary base, which in this scenario would be a alteration in reserves because the currency holding by the investing community would be constant aiming a money cumulative may function because the correlation between the money target and a shift in reserves would be steady.
The issue that is being faced by the Fed today is that the association between the money supply and a shift in the monetary base is capricious since the Fed cannot check or curb what banks will react with excess reserves or do they check the public’s currency holdings . Consequently, as an alternative of aiming a money aggregate, Fed would rely on an interest rate. One the other hand, if the Fed has to aim at money aggregate, Fed would have to abandon aiming an interest rate since Fed cannot exercise both options simultaneously.
Thus, under the above scenario, Fed has the two only two alternatives namely either it can rely on interest rates or at money at aggregate , it cannot pursue both the options at a time.
Ireland, P. N. (2000). Interest Rates, Inflation and Federal Reserve Policy since 1980. Journal of Money, Credit & Banking, 32(3), 417. US Fed Must Weigh Variety of Signals to Set Interest Rates. (2006, March 22). Manila Bulletin, p. NA.
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