14_Lecture - LECTURE 14 MORE ON INFLATION INTEREST RATES AND THE BUSINESS CYCLE , .Lookathowlowthe .Inonemonthitwas0.03

14_Lecture - LECTURE 14 MORE ON INFLATION INTEREST RATES...

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LECTURE 14 MORE ON INFLATION, INTEREST RATES AND THE BUSINESS CYCLE In Table 14-2 which was part of Lecture 13, I included the T-bill rates for the  two troughs of the Great Depression in 1933 and 1938.  Look at how low the  nominal interest rate fell during the Depression.  In one month it was 0.03%.  Note that this is not 3%.  It is 3/100 of 1%.  It is not significantly different from  zero.  Milton Friedman once told me that the 3-month T-bill rate actually went  negative  for a short period of time during the Depression.  After a significant  amount of research, and the help of a colleague, I have been able to confirm  this. 1   Not only did T-bill rates go negative, they went negative on notes and  bonds as well, both at auction and when traded in the secondary market.  I  hypothesize why, below. I also pulled some prime rate numbers.  The prime rate is the loan interest  rate that the biggest banks, such as J.P. Morgan-Chase, charge their best  customers, such as I.B.M. and Caterpillar.  It tends to change slowly, and  serves as the basis of other interest rates in the economy, as a benchmark. The Federal Funds rate is the interest rate  targeted  by the Federal Reserve  System, and is the rate that banks charge each other when banks lend and  borrow bank reserves (money) from each other.  The  Federal Reserve  Discount Rate  is the interest rate the Federal Reserve charges a bank, like  J.P. Morgan-Chase, when J.P.M. borrows reserves (money) from the Fed.  In  March 2008, the Fed's discount rate was set at 25 basis points (1/4 of 1%)  above the target Federal Funds rate. 3   In February 2010, the Fed increased  the discount rate by 25 basis points to .75 percent from .5 percent where it  1 Cf. Annual Report of the Secretary of the Treasury, 1941, and U.S. Treasury Bulletin for 1939. 2 In recent years, credit markets have started linking their interest rates to the L.I.B.O.R. (the London Interbank Offer Rate) which is the interest rate big international banks charge each other when they lend money to each other. (Only U.S. banks can use the Federal Funds Market.) Unlike the Federal Funds rate and the prime rate, when the market is open, the LIBOR changes minute to minute, based on credit conditions (supply and demand). As such, a lot of credit instruments with changeable interest rates (like "adjustable-rate mortgages") are tied to the LIBOR rather than the prime rate because the LIBOR adjusts to new conditions in the market quickly, while the Federal Funds rate and the prime rate can lag.

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