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Unformatted text preview: the inflation–adjusted, or real, yields on their investments. Consequently, interest rates will tend to end up higher than their starting level– just the opposite of the short–run effect. The misperception that easy money can permanently lower interest rates is based solely on the initial effect–an increase in the supply of loanable funds; it ignores subsequent upward pressures on interest rates caused by increased economic activity and the higher inflation that occur later. Both changes in inflation premiums and the state of the business cycle are important determinants of short–term interest rates. Compared to their levels in earlier periods,
Dynasty School (www.dynastySchool.com) 2-25 REAL ESTATE FINANCE
interest rates have been high and variable since the 1970's, largely owing to historically high and variable inflation rates. Also, the state of the business cycle has influenced the timing of interest–rate movements. For example, in 1974, the interest rates started to decline before the inflation rate declined because the business–cycle recession reduced the demand for loanable funds. STRATEGIES AND OPERATING PROCEDURES INDICATORS OF MONETARY POLICY
Setting targets for money growth to achieve monetary policy's ultimate goals is a recent innovation in the Federal Reserve's procedures. Money–growth targets were not adopted until the early 1970's. Prior to that, the Federal Reserve (like most central banks) judged the thrust of monetary policy whether it was easy or tightly looking at interest rates. Lowering interest rates were taken as indications that monetary policy was being expansionary, while higher interest rates were judged to be a sign that monetary policy was tight. The Fed's monetary policy instruments open market operations and the discount rate–were used to adjust interest levels that were believed to be consistent with the ultimate objectives for inflation and unemployment. Thus, when the economy appeared to be overheating and to be raising the threat of inflation, open market operations were used to drain reserves and to contract deposits and bank loans so that interest rates would rise. The rise in interest rates was expected to dampen sp...
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This note was uploaded on 12/30/2010 for the course SOC 101 taught by Professor Zhung during the Spring '10 term at Punjab Engineering College.
- Spring '10