Interest As Backbone of Modern Economy - Part 4
Posted: Saturday, November 14, 2009
by Shafi Farooq
http://mywebsiteworkout.com/personal-finances/
In modern world, especially the Western world and Japan, interest rate is considered the backbone of modern finances and that includes your family finances as well. It affects and impacts us all in every walk of life. Individuals and families ought to understand its importance.
The interest comes into play when we borrow money or lend money. Everyone is affected when the interest rate goes up or when it comes down. This backbone of the economy is controlled by the central bank of a country. In the U.S., it is called Federal Reserve Bank, commonly know as the Fed.
A time comes in the national economy that it can become overheated. That means that there is more and more demand for goods and services than businesses can meet. More and more people are employed. People, then, have more money to spend. The economy is in full swings. I am using the word or rather the concept "more" so often, it reminds me of the good old days.
This activity can result in higher inflation. Now that, eventually, can damage your pocketbook. Higher inflation also damages the economy by reducing the purchasing power of a dollar.
One of the Fed's most important job is to keep inflation in check. And for that, one of its key tools is the discount rate. The Fed determines that businesses and families should have harder time to get loan from their banks to slow the economy and eventually lower the inflation.
So the Fed raises the discount rate, thereby, increasing the cost of borrowing which will start slowing the economy. And thus, this action by the Fed dampens the threat of higher inflation.
The reverse is true as well. Lowering the discount rate reduces the cost of money to banks, thus facilitating businesses and families to be able to borrow more money. That in turn, stimulates the economy.
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