Analysis Of "The Federal Reserve Discount Rate And The Effect That It's Reduction Has Had On The U.S. Economy"
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Authors
Parsons, Bradley
Issue Date
1992
Type
Thesis
Language
en_US
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Abstract
The purpose of section I of this paper is to examine the Federal
Reserve discount rate as a monetary tool, as well as the impact that its
recent reductions have had on the U.S. economy.
Whenever the discount rate is reduced, it historically has had the
effect of causing all of the various market interest rates to also fall.
According to traditional monetary theory, this should have a significant
impact on economic activity within the the United States. First of all, as
lower interest rates strengthen the net reserve positions of the nation's
banks, this should then make them more willing to extend additional credit
to consumers and business firms at a lower cost. Business firms should
then take advantage of the lower cost of capital to increase investment
expenditures, thus leading to a higher level of output and employment.
Additionally, consumers should be induced to borrow more and save less,
therefore leading to an increase in consumption expenditures.
Contrary to theoretical expectations, this has not taken place. The
nation's banks have been hesitant to lend funds, business firms have not
increased their investment, and consumers have not significantly
increased their consumption outlays. As a result, the U.S. economy has
been slow to emerge from its current recessionary state.
The conclusion drawn from this is that interest rates are only one of
many economic variables that have an effect on the economy. In the case of
the nation's banks, such factors as a more conservative attitude towards
extending credit and an insufficient borrowing demand for additional loan
funds have acted to restrain growth. As for business firms, a high level of
internal financing, uncertain future business forecasts, and a short-term
positive correlation between interest rates and business investment have
slowed down investment expenditures. Likewise, consumers have been
preoccupied with a relatively weak liquidity position, a high level of
unemployment, and dismal future expectations about the economy's ability
to pull itself out of the recession. Therefore, lower interest rates have not
been able to significantly boost consumer outlays. All of these economic
factors are not accounted for in the traditional monetary theory, yet all of
them have played a key role in determining the nation's current level of
economic activity.
The theoretical information and empirical data which this paper is
based on is solely dependent on the following sources; Economic textbooks
which deal with monetary theory, current magazine and newspaper
articles, confidential interviews, the U.S. Department of Commerce, and
the 1992 Economic Report of the President.
Section II and III, respectively, simply explain the internship part of
this SIP and how it has had a direct impact on my post-graduate plans.
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75 p.
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