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January 31, 1996
PAUL SOLMAN ON THE FEDERAL RESERVE AND INTEREST RATES
This week the Federal Reserve decided to lower interest rates. Paul Solman, the NewsHour's economic correspondent, takes your questions on the role of the central bank in our economy. Mr. Solman has reported in the past that the Fed's control over the interest rate - the rate at which banks lend money - holds sway over financial markets. Should the Federal Reserve have the control it does? If not, how does the country keep growth and inflation rates under control?
Click here for a past Solman report on the effects of interest rate changes on the economy.
A question from C. Puckett of Clarksburg, Maryland:If not the Fed, then who? Today it's the only way the people can effect change in so great an empire, (excuse the term), even if control is slight and takes a long time. If we abandon the Fed we'll get a collection of Wall Street bankers or worse, (control from ) overseas.
Paul Solman responds:
An unusual question. Historically, populists have damned the Fed as THE representative of Wall St. and corporate interests, in that the Fed (according to populists) has been more worried about inflation than unemployment, and inflation hurts people WITH money, by making it less valuable.
A question from Lynn Brielmaier from Houston, Texas:
A local investment guru here says that the Fed inevitably REDUCES rates during an Election Year.
To look at the current situation, we see the Fed RAISING rates two years ago, in order to REDUCE rates now. This is a very cynical manipulation of the money supply for political reasons, which historically dates back to before the Great Depression.
What do you think about the cyclical nature of money supply verses election cycles???
Paul Solman responds:
Political influence over the Fed has been a criticism for generations. (The Fed was established in 1913, basically to keep financial panics from occurring.) The "election cycle" has long been alleged. In fact, the whole point of keeping the Fed separate from government is to buffer it from political influences. I think most experts would agree that the Fed is in fact pretty well buffered. Usually made up of Democrats and Republicans, the Open Market Committee (which decides on monetary policy and thus interest rates) probably acts more on what it thinks is good for the economy than for its favorite candidate or party.
A question from David Roth of Sausalito, California:
Politicians today are promising 2% to 4% interest rates as one of the rewards for a balanced budget. Can we believe that? If low interest rates will be such a great thing for everybody, then why doesn't the Fed just take action to lower rates now?
Paul Solman responds:
Whenever asked a predictive question, like your first one, I quote John Kenneth Galbraith, who says "There are two kinds of economists: those who don't know the future and those who don't know they don't know." I suppose rates WOULD go down some, given a balanced budget, all else equal, but by HOW MUCH is anybody's guess. Besides, all else won't be equal (i.e., other things will happen to affect interest rates and it will be very hard to sort them out from the influence of the balanced budget).
As to your second question, remember, the Fed lowers rates by putting more money into the banking system. (See the Fed "explainer" on the show tonight.) Too much money, and you get inflation. Getting interest rates to go down on their own is far preferable.
Finally, two questions for you. (1) Do you live on one of those amazing houseboats? If so, (2), wanna swap houses?
A question from Eleni Kirkas of Atlanta, Georgia:
Who monitors the Fed and does anyone have the power to veto its decisions? Also, how does the personality of Federal Reserve Board's Chairman effect interest rates, and the direction of the Board?
Paul Solman responds:
Fed members are appointed to office, the main ones by the President. No one has veto power or even, supposedly, influence. As to the chairman's personality, it must be like everything else in life: the more powerful it is, the more influence the chairman wields. And not too many wimps get appointed chairman.
A question from Amy Svatek of Williamsburg, Virginia:
We're often told to act like the Japanese, and save more of our income. But it seems more and more lately, interest rates are going down, encouraging consumption rather than savings. It seems like the Fed is making policy that entrenches the American culture of consumption. Is the Federal Reserve looking out for corporations rather than individuals?
Paul Solman responds:
The reason to lower interest rates is to stimulate BOTH pieces of the economy: consumption AND investment.
The idea is that lower interest rates will make investments more attractive to businesses, which would make them build more for the future, (since money is cheaper today), which would make us MORE like the Japanese. But of course, that's just the theory.
There are lots of other things going on at the same time in the economy. And if lower rates simply cause people to BUY more while companies don't INVEST more, then we're LESS like the Japanese. On the other hand, all that investing hasn't done the Japanese too much good as of late, because it seems to have meant rigging their economy in unhealthy ways, or at least ways that have been unhealthy for the past few years. See why I have a job? This stuff is so complicated and iffy, NO ONE can really give categorical answers.
ADDITIONAL THOUGHTS
Comments from visitors to our site, in addition to those answered by Paul Solman.
Eric Norris of Santa Clara, California:
In whose interest is the Fed acting? I hear repeatedly that low interest rates are favorable for buying homes, but what about those who own homes? How can a person accumulate any real equity without a moderate inflation rate that makes his home worth more over time? Also, aren't the unemployment numbers, that the Fed supposedly takes into account, really grossly underestimating the unemployed since, if I understand this correctly, after six months they are no longer counted as being among the unemployed? Too, those who are underemployed are aren't counted either, yet many are working part-time or working without benefits as temps or contractors.
So, how much do you think the Fed bases its decisions on what would be best for the citizens of the U.S., and how much does it base its decisions on what would be best for the financial community? Is the Fed acting in our interest? Or is it acting in the interest of the financial heavy hitters who live off investments?
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Robert Markowitz of Los Angeles, California:
Nearly everybody agrees that the present wages of the average worker has not risen in the rising economic tide. The question is: How do we raise workers' wages without setting inflation in motion? And if the answer is "more productivity", aren't the present stripped down companies already at a productivity high?
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