Fed http://www.wisebread.com/taxonomy/term/7630/all en-US 10 Stocks and Bonds That Will Profit From the Fed Rate Hike http://www.wisebread.com/10-stocks-and-bonds-that-will-profit-from-the-fed-rate-hike <div class="field field-type-filefield field-field-blog-image"> <div class="field-items"> <div class="field-item odd"> <a href="/10-stocks-and-bonds-that-will-profit-from-the-fed-rate-hike" class="imagecache imagecache-250w imagecache-linked imagecache-250w_linked"><img src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/imagecache/250w/blog-images/interest_rate_increase_000020286301.jpg" alt="Finding stocks and bonds that will profit from the fed rate hike" title="" class="imagecache imagecache-250w" width="250" height="140" /></a> </div> </div> </div> <p>The Federal Reserve finally did what it's been hinting at for some time, and raised the target on its benchmark rate by a quarter of a percentage point. It's the first interest rate hike after spending much of the last decade with interest rates near zero.</p> <p>Interest rates are still going to be historically quite low, but some investments may decline in value in the short term. After all, it's the low interest rate environment that has <em>partly </em>fueled the rise in stock prices in recent years.</p> <p>That said, it's still very possible to profit even as interest rates go up. There are some market sectors that love higher rates, and in general, a rise in rates is a signal from the Fed that the nation's economy is healthy. (See also:&nbsp;<a href="http://www.wisebread.com/this-is-how-much-the-feds-interest-rate-hike-might-cost-you">This Is How Much the Fed's Interest Rate Hike Might Cost You</a>)</p> <p>Here are ten investments that might respond well as interest rates go up.</p> <h2>1. SPDR S&amp;P Regional Bank ETF [<a href="http://finance.yahoo.com/q?s=KRE">NYSE: KRE</a>]</h2> <p>When interest rates rise, small banks do quite well because more people are willing to increase their cash holdings. This ETF counts many strong small banks in its portfolio, including Bank of the Ozarks and Great Western Bancorp. This ETF has seen a return of more than 13% over the last year, suggesting that the anticipation of higher rates may already be baked into the price. But it's still worth buying.</p> <h2>2. Wells Fargo [<a href="http://finance.yahoo.com/q?s=WFC">NYSE: WFC</a>]</h2> <p>If smaller banks aren't your thing, then take a look at some big banks. Billionaire investor Warren Buffett owns more shares of Wells Fargo than any other company. New loans made by the bank will benefit from the higher rates, as will any existing variable rate loans. Other big banks worth a look include US Bancorp and BNY Mellon.</p> <h2>3. Schwab Short-Term U.S. Treasury ETF [<a href="http://finance.yahoo.com/q?s=SCHO">NYSE: SCHO</a>]</h2> <p>The conventional wisdom is that a hike in interest rates make long-term bonds less attractive, but short-term bonds perform well. Consider that the yield on a two-year treasury note hit a year high recently. Charles Schwab reported that during the three periods when the Fed rose rates since 1990, short-term bonds were the only sector that saw increases each time. This ETF from Schwab has some of the lowests fees on the market, so it's likely a good buy if you're interested in fixed income investments. The iShares Short Treasury Bond ETF is also well regarded.</p> <h2>4. Apple [<a href="http://finance.yahoo.com/q?s=AAPL">NYSE: APPL</a>]</h2> <p>It's the biggest company in the world. It has a very healthy balance sheet. In a time of raising rates and general uncertainty, it's good to hang with companies that have solid margins, lots of cash, and low volatility. Any blue chip stock with a long track record of steady growth is a good buy in this environment.</p> <h2>5. Alphabet [<a href="http://finance.yahoo.com/q?s=GOOGL">NYSE: GOOGL</a>]</h2> <p>Another one of the largest and most stable companies in the world, most likely unaffected by a rise in interest rates. Investing in Google's parent company can help keep you insulated from any market uncertainty over the next few months.</p> <h2>6. MetLife [<a href="http://www.google.com/finance?cid=664378">NYSE: MET</a>]</h2> <p>There are few sectors clamoring for an interest rate hike more than life insurers. These companies rely on interest income to boost their margins, so they generally have not been fans of the low interest rate environment. MetLife is the a largest company in this sector. Prudential and New York Life are also worth a look.</p> <h2>7. Accushares VIX Index ETF [<a href="http://finance.yahoo.com/q?s=VXUP">NYSE: VXUP</a>]</h2> <p>It's not entirely clear how the markets will react to the news of the interest rate bump, but most observers predict some amount of volatility in the short term. You can capitalize on that volatility by buying shares of this ETF that is based on the most common volatility index. It's an esoteric product, and I wouldn't invest my life savings into it, but it may be one way to capitalize on investor uncertainty.</p> <h2>8. Starbucks [<a href="http://finance.yahoo.com/q?s=SBUX">NYSE: SBUX</a>]</h2> <p>If the Fed is raising interest rates, it's sending a signal that it believes the economy is in good shape. And a strong economy means people are doing well enough to afford discretionary items, including that morning cup of coffee. Starbucks is a leader in the restaurant/food area, and should benefit from a strong economy overall.</p> <h2>9. Mastercard [<a href="http://www.google.com/finance?cid=299286">NYSE: MA</a>]</h2> <p>Goldman Sachs put this credit card company on its list of &quot;quality&quot; stocks worth buying in advance of a rate hike, and its reasoning is sound. If the economy is strong in the Fed's eyes, then it's strong enough for people to be buying more goods and services. Companies like Mastercard do better when people go shopping.</p> <h2>10. Chipotle Mexican Grill [<a href="http://finance.yahoo.com/q?s=CMG">NYSE: CMG</a>]</h2> <p>Shares of this burrito eatery have tumbled in the last few months, in part due the company being linked to cases of <em>e.coli</em> around the country. But assuming that the cases aren't indicative of a larger problem with the restaurant, this is a well-regarded company with a solid balance sheet. Chipotle shares should be poised for a rebound with the Fed showing confidence in the nation's economy.</p> <p><em>Will your portfolio be helped or hurt by the Fed's recent rate increase?</em></p> <br /><div id="custom_wisebread_footer"><div id="rss_tagline">This article is from <a href="http://www.wisebread.com/tim-lemke">Tim Lemke</a> of <a href="http://www.wisebread.com/10-stocks-and-bonds-that-will-profit-from-the-fed-rate-hike">Wise Bread</a>, an award-winning personal finance and <a href="http://www.wisebread.com/credit-cards">credit card comparison</a> website. Read more great articles from Wise Bread:</div><div class="view view-similarterms view-id-similarterms view-display-id-block_2 view-dom-id-3"> <div class="view-content"> <div class="item-list"> <ul> <li class="views-row views-row-1 views-row-odd views-row-first"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/5-crucial-things-you-should-know-about-bonds">5 Crucial Things You Should Know About Bonds</a></span> </div> </li> <li class="views-row views-row-2 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/laddering-for-higher-more-stable-returns">Laddering for higher, more stable returns</a></span> </div> </li> <li class="views-row views-row-3 views-row-odd"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/the-only-8-rules-of-investing-you-need-to-know">The Only 8 Rules of Investing You Need to Know</a></span> </div> </li> <li class="views-row views-row-4 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/the-best-ways-to-invest-50-500-or-5000">The Best Ways to Invest $50, $500, or $5000</a></span> </div> </li> <li class="views-row views-row-5 views-row-odd views-row-last"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/7-cool-things-bonds-tell-you-about-the-economy">7 Cool Things Bonds Tell You About the Economy</a></span> </div> </li> </ul> </div> </div> </div> </div><br/></br> Investment bonds borrowing Fed interest rates investing stocks Thu, 17 Dec 2015 12:00:08 +0000 Tim Lemke 1622171 at http://www.wisebread.com 5 Financial Holidays I'd Like to See http://www.wisebread.com/5-financial-holidays-id-like-to-see <div class="field field-type-filefield field-field-blog-image"> <div class="field-items"> <div class="field-item odd"> <a href="/5-financial-holidays-id-like-to-see" class="imagecache imagecache-250w imagecache-linked imagecache-250w_linked"><img src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/imagecache/250w/blog-images/iStock_000012232049Small-2.jpg" alt="Woman with falling money" title="Woman with falling money" class="imagecache imagecache-250w" width="250" height="143" /></a> </div> </div> </div> <p>There are far too many holidays in this day and age, if you ask me. National Lox and Bagels Day or Turkey Neck Soup Day are little more than reasons to boost the food industry, and they are not something that most of us celebrate with vigor. If you had me design next year&rsquo;s calendar, however, I would add a few holidays that would do quite a bit of good for the average consumer. Here are my proposed celebrations; feel free to add them into any day or month you choose.</p> <p><img height="351" width="605" alt="" src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/u921/gift_cards.jpg" /></p> <h3>Gift Card Balance Awareness Month</h3> <p>If you&rsquo;re like most Americans, you have a drawer in your office with random gift cards &mdash; and possibly no clue as to the balance of each. It takes a bit of work, but you can call about each or check the balances online to see where you stand. Most major brand cards, like Starbucks, for example, can be combined into one gift card, making those small $1 or less balances useful again. Other cards, like those VISA or American Express gift cards, will need a bit more creative repurposing. (See also: <a title="How to Use Up Remaining Balances on Prepaid Gift Cards" href="http://www.wisebread.com/how-to-use-up-remaining-balances-on-prepaid-gift-cards">How to Use Up Remaining Balances on Prepaid Gift Cards</a>)</p> <p><img height="454" width="605" alt="" src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/u148/thank%20you.jpg" /></p> <h3>Money Mentor Appreciation Week</h3> <p>Most of us can name one person, at least, who has influenced us in a positive regard to our finances. For me, it&rsquo;s my husband and this <a title="Five Financial Gurus You've Never Heard Of" href="http://financialhighway.com/5-financial-gurus-youve-never-heard-of/">list of five financial gurus you&rsquo;ve never heard of</a>. If you know a blogger, author, financial professional, or family member who has helped you take your finances by the reigns and get things right, it&rsquo;s time to say &ldquo;thanks.&rdquo; You can send a letter, shoot them an email, buy their new book, subscribe to their RSS feed, or even make a donation to their favorite charity or their non-profit organization. It&rsquo;s a fantastic way to show you how you feel!</p> <h3><img height="403" width="605" alt="" src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/u148/fed.jpg" /></h3> <h3>Fed Day</h3> <p>It could be argued that every day is fed day (it does, after all, seem like the controlling arm of so many things). I would like to approach the subject from the point of view of an American living in this somewhat complex economy, however. If you don&rsquo;t know your ins and outs of our Federal Reserve System, it&rsquo;s best to schedule a day (or week) this year to do so. Start out simply, with a reading from the <a title="Federal Reserve System" href="http://en.wikipedia.org/wiki/Federal_Reserve_System">Wiki page</a>. Then graduate to commentary by political and economic analysts on both sides of the spectrum. You don&rsquo;t have to learn everything at first, but living in today&rsquo;s somewhat tumultuous times requires some knowledge of what&rsquo;s going on. It&rsquo;s best to set aside time to get ahead of the curve. (If you have kids, who likely aren&rsquo;t learning this in school, pull them in for some of the more basic principles.)</p> <p><img height="403" width="605" src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/u148/iou.jpg" alt="" /></p> <h3>National &quot;Give Back&quot; Month</h3> <p>No, this isn&rsquo;t a feel-good attempt at giving people a chance to contribute to charities. It is, however, a great excuse to pencil in a month on your calendar to pay back loans; give back borrowed CDs, movies, and lawn tools; and return any favors you swore you would grant. People are generally becoming less and less good about keeping their word. (This is evidenced by the rising number of mortgage defaults and bankruptcies, and general attitudes towards paying back debt.) If you can&rsquo;t pay it all back at one, work out a payment plan, consider counselling with a debt management service, or look into other ways to make good on your loan. We are as solid as our promises, after all. (Not sure you have what it takes to stare down tens of thousands of dollars in debt? Check out how <a href="http://financialhighway.com/i-paid-off-50000-in-credit-card-debt-and-you-can-too/">I paid off over $50,000 in credit card debt</a>.)</p> <p><img height="453" width="605" src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/u148/trash%20can.jpg" alt="" /></p> <h3>Check It or Chuck It Week</h3> <p>We all suffer from variations of a common disease known as &ldquo;too much stuff&rdquo; &mdash; except for a few of my nomadic or military friends. I have often wondered how much of my possessions I would miss in case of a natural disaster. As sad as this is, it is often just the process of deciding what to do with &ldquo;stuff&rdquo; that can be a burden. Do you keep it? Sell it? Give it away? What if you need it later? While it&rsquo;s silly to assume that you can go through your home, garage, and outdoor buildings in just one week, putting purpose to everything you own, picking just one room this week to purge of the excess is a great start. (Need tips for moving forward? How about starting with these <a title="Toss It or Not?" href="http://www.wisebread.com/toss-it-or-not-5-organizational-tips-from-a-chronic-clutter-bug">tips for clearing clutter</a> from a self-proclaimed clutter bug?) A decrease in clutter can save you money, free up some time, and give back much-needed mental and emotional clarity.</p> <p>Looking for some real holidays to boost your financial intelligence or savings potential? Why not check out <a title="Financial Literacy Month" href="http://www.financialliteracymonth.com/">Financial Literacy Month</a>, <a title="I Love Coupon Month" href="http://www.ilovecouponmonth.com/">National Coupon Month</a>, or even &ldquo;<a title="No Pants Day" href="http://www.nopantsday.com/wp/">No Pants Day</a>&rdquo; (which is coming up soon and can save you a little on the cost of getting your pants pressed)?</p> <p><em>What financial holidays would you like to be celebrated? Or do we just have enough to think about already?</em></p> <br /><div id="custom_wisebread_footer"><div id="rss_tagline">This article is from <a href="http://www.wisebread.com/linsey-knerl">Linsey Knerl</a> of <a href="http://www.wisebread.com/5-financial-holidays-id-like-to-see">Wise Bread</a>, an award-winning personal finance and <a href="http://www.wisebread.com/credit-cards">credit card comparison</a> website. Read more great articles from Wise Bread:</div><div class="view view-similarterms view-id-similarterms view-display-id-block_2 view-dom-id-1"> <div class="view-content"> <div class="item-list"> <ul> <li class="views-row views-row-1 views-row-odd views-row-first"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/swipe-envy">Swipe envy</a></span> </div> </li> <li class="views-row views-row-2 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/12-personal-finance-skills-everyone-should-master">12 Personal Finance Skills Everyone Should Master</a></span> </div> </li> <li class="views-row views-row-3 views-row-odd"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/could-you-save-money-by-subscribing-to-an-addictive-game">Could you save money by subscribing to an addictive game?</a></span> </div> </li> <li class="views-row views-row-4 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/eight-natural-ways-to-make-water-more-flavorful">Eight Natural Ways to Make Water More Flavorful</a></span> </div> </li> <li class="views-row views-row-5 views-row-odd views-row-last"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/4-brilliant-tips-from-smart-mom-rich-mom">4 Brilliant Tips From &quot;Smart Mom, Rich Mom&quot;</a></span> </div> </li> </ul> </div> </div> </div> </div><br/></br> Personal Finance Frugal Living decluttering Fed gift cards Holidays mentorship Wed, 04 May 2011 10:24:47 +0000 Linsey Knerl 535415 at http://www.wisebread.com Oh noes! Inflation! http://www.wisebread.com/oh-noes-inflation <div class="field field-type-filefield field-field-blog-image"> <div class="field-items"> <div class="field-item odd"> <a href="/oh-noes-inflation" class="imagecache imagecache-250w imagecache-linked imagecache-250w_linked"><img src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/imagecache/250w/blog-images/monetary-base-small.png" alt="Graph of monetary base showing recent surge" title="Graph of monetary base showing recent surge" class="imagecache imagecache-250w" width="250" height="150" /></a> </div> </div> </div> <p>The Wall Street Journal has an opinion piece by Arthur Laffer that shows a scary graph of the monetary base, which has surged enormously in the past year.&nbsp; He suggests that this is &quot;potentially far more inflationary&quot; than the monetary policies of the 1970s.&nbsp; I'm as worried about inflation as anybody, and agree that the Fed should already be taking steps to minimize it, but I think Laffer is off-base here.</p> <p>Here's a graph much like the one in the <a href="http://online.wsj.com/article/SB124458888993599879.html">Wall Street Journal opinion piece</a>, showing the recent spike in the monetary base.&nbsp; You can see a couple of earlier, much smaller spikes when the Fed took action in advance of Y2K and after 9/11.&nbsp; Scary, no?</p> <p><img src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/u203/monetary-base.png" alt="Graph of monetary base showing recent surge" /></p> <p>Except, here's a view of changes in the monetary base from 1984 to mid-2008 (i.e. until the recent spike), together with CPI inflation over the same period.&nbsp; Notice a strong correlation between changes in the monetary base and future inflation?&nbsp; No?&nbsp; Me neither.</p> <p><img src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/u203/monetary-base-cpi-1984-2008_0.png" alt="Graph of monetary base and CPI from 1984 through mid-2008" /></p> <p>Okay, here's another.&nbsp; This is the M2 money supply versus CPI inflation from 1984 through mid-2008.&nbsp; To my eye, that at least shows some correlation--the money supply rises before inflation heats up and then drops when inflation drops.&nbsp; The correlation doesn't look so hot from 1995 through 2005, but we are starting to get a better picture of what happened then--the excessive money supply growth pumped up asset prices (the dotcom bubble), while globalization held down consumer prices.</p> <p><img src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/u203/m2-cpi-1984-2008.png" alt="Graph of M2 money supply and CPI from 1984 though mid-2008" /></p> <p>So, what does that tell us?&nbsp; Maybe not a lot.&nbsp; But, if M2 money supply is of at least some use for prediction future inflation, here's another look--the same graph, but this time running up to the latest data available.&nbsp; The CPI rate has plummeted--the year-over-year change in prices actually going negative due to the combination of falling fuel prices, the financial collapse, and the recession.&nbsp; But look at M2--the rate of change there is hardly unprecedented.&nbsp; We saw similar spikes in the mid-1980s and then again when the Fed eased monetary policy in the wake of the dotcom crash.&nbsp; That is liable to lead to some inflation, but it's an ordinary risk of an ordinary rate of inflation--not some huge hyperinflationary catastrophe.</p> <p><img src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/u203/m2-cpi-1984-2009.png" alt="Graph of M2 money supply and CPI from 1984 to the latest data available" /></p> <p>Now, I don't want to minimize the dangers of the surge in the monetary base.&nbsp; If that potential for money creation is realized as actual growth in the money supply, then we can kiss the dollar good-bye.&nbsp; But although the surge is unprecedented in its magnitude, there's actually a good example of the Fed managing a monetary-base spike without producing a catastrophe--the results of their actions in the run-up to Y2K.&nbsp;</p> <p>Concerned that the Y2K bug might take down the computers that ran the ATMs, the banks, and the communications networks that connected the banks, the Fed made sure that there was extra cash in the hands of the banks and extra reserves in the banking system, just in case.&nbsp; Then, when it turned out that nearly everyone had fixed all their important Y2K bugs, they drained the excess reserves.&nbsp; Here's a close-up of the monetary base and CPI during that period, showing no sign of wild swings in prices.&nbsp; That's not proof that we won't have a huge inflationary spike, but it does show that it's at least possible to have large swings in monetary base growth without adverse impact on prices.</p> <p><img src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/u203/monetary-base-cpi-1999-2001.png" alt="Graph of monetary base and CPI before and after Y2K" /></p> <p>I'm worried about inflation too; I just don't think the scary monetary base graph is the reason to be scared.</p> <br /><div id="custom_wisebread_footer"><div id="rss_tagline">This article is from <a href="http://www.wisebread.com/philip-brewer">Philip Brewer</a> of <a href="http://www.wisebread.com/oh-noes-inflation">Wise Bread</a>, an award-winning personal finance and <a href="http://www.wisebread.com/credit-cards">credit card comparison</a> website. Read more great articles from Wise Bread:</div><div class="view view-similarterms view-id-similarterms view-display-id-block_2 view-dom-id-1"> <div class="view-content"> <div class="item-list"> <ul> <li class="views-row views-row-1 views-row-odd views-row-first"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/watch-out-for-surge-in-cpi">Watch Out for Surge in CPI</a></span> </div> </li> <li class="views-row views-row-2 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/stag-hyperinflation">Stag-hyperinflation?</a></span> </div> </li> <li class="views-row views-row-3 views-row-odd"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/inflation-is-going-away-for-a-while">Inflation is going away for a while</a></span> </div> </li> <li class="views-row views-row-4 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/federal-reserve-cuts-the-discount-rate">Federal Reserve cuts the discount rate</a></span> </div> </li> <li class="views-row views-row-5 views-row-odd views-row-last"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/dont-let-low-interest-rates-make-you-stupid">Don&#039;t let low interest rates make you stupid</a></span> </div> </li> </ul> </div> </div> </div> </div><br/></br> Personal Finance cpi Fed Fed funds rate fed policy federal reserve inflation interest rates M2 monetary policy money money supply Fri, 12 Jun 2009 08:39:45 +0000 Philip Brewer 3257 at http://www.wisebread.com Stag-hyperinflation? http://www.wisebread.com/stag-hyperinflation <div class="field field-type-filefield field-field-blog-image"> <div class="field-items"> <div class="field-item odd"> <a href="/stag-hyperinflation" class="imagecache imagecache-250w imagecache-linked imagecache-250w_linked"><img src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/imagecache/250w/blog-images/forest-pool.jpg" alt="Forest pool" title="Forest Pool" class="imagecache imagecache-250w" width="250" height="171" /></a> </div> </div> </div> <p>Stagflation, the bane of the 1970s, is pretty much the worst situation for ordinary folks.&nbsp; With the economy depressed, jobs are scarce for workers and profits are scarce for business owners.&nbsp; With entrenched inflation, everyone's savings are constantly eroding.&nbsp; The result is that nowhere is safe for your money:&nbsp; not cash, not your business, not the market.&nbsp; With the latest moves by the Fed, I fear we're facing a repeat--only it'll be worse this time:&nbsp; stag-hyperinflation.</p> <p>We know what produces inflation:&nbsp; excess growth in the money supply.&nbsp; This was a matter of some dispute back in the 1970s.&nbsp; In those days, many people thought that government deficits were the culprit--that when the government borrowed money and spent it on stuff, the &quot;excess&quot; demand bid up prices.&nbsp; The experience of the 1980s proved otherwise:&nbsp; Strong measures to hold the line on money supply growth by the Federal Reserve under Paul Volker brought inflation under control despite record deficits.</p> <p>Bringing money supply growth down to the level of economy growth will bring inflation to a stop.&nbsp; However, it will also produce a recession.&nbsp; (This is pretty much inevitable.&nbsp; The inflation, by producing the illusion of growth, will have fooled businesses into making unwise investments.&nbsp; When the growth fails to materialize, businesses that expanded will have to contract--which is exactly what a recession is.)</p> <p>Just as we understand inflation and recession, we also <a href="http://www.wisebread.com/all-about-stagflation">understand stagflation</a>.&nbsp; You get stagflation when you repeatedly try to bring inflation down, but then keep chickening out at the first whiff of recession.</p> <p>Unlike in the 1970s, our current spot of trouble was kicked off as an old-fashioned financial panic, which is a <strong>deflationary</strong> event.&nbsp; A year ago, I was worrying about inflation.&nbsp; (I wrote about <a href="http://www.wisebread.com/how-to-live-with-inflation">How to live with inflation</a> and <a href="http://www.wisebread.com/budgeting-in-a-time-of-inflation">Budgeting in a time of inflation</a> and <a href="http://www.wisebread.com/will-high-inflation-persist">Will high inflation persist</a>.)</p> <p>By October last year, though, I had figured out that the deflationary effects of the financial panic were going to squelch the inflationary effects of Federal Reserve policy.&nbsp; (I wrote a post called <a href="http://www.wisebread.com/inflation-is-going-away-for-a-while">Inflation is going away for a while</a>.)&nbsp; With economic activity plummeting, prices of global commodities fell as well.&nbsp; Consumers trying to pay off debts and boost savings kept a lid on prices of consumer goods as well.</p> <p>(As an aside, it's worth emphasizing that not all price increases are inflation.&nbsp; Inflation is the <em>money becoming less valuable</em>.&nbsp; Sometimes, though, prices go up for other reasons.&nbsp; Resource depletion makes key resources more expensive to produce, pushing up the prices of raw materials, and eventually the prices of everything made with those resources.&nbsp; Globalization pushes down the prices of things available in global trade, making things that are only available on local markets relatively more expensive.&nbsp; People's tastes change, producing changes in relative prices.&nbsp; All of these things can look like inflation, if all you've got to go by is price statistics.)</p> <p>The Federal Reserve is in a tizzy.&nbsp; They're terrified of deflation--money becoming <em>more</em> valuable--because the experience of the Great Depression shows that a deflationary collapse can not only bring down the whole economy but keep it down <em>for years</em>.&nbsp; Contrariwise, they know how to stop inflation.&nbsp; This asymmetric situation has prompted them to boost the money supply in <strong>an effort to create a modest amount of inflation</strong>.</p> <p>Normally, the Fed can create inflation no problem--they create additional bank reserves, the banks lend more money, the money supply goes up, and you've got your inflation.&nbsp; (It shows up in prices when people spend the borrowed money--prices get bid up because there's more money but no more stuff.)&nbsp; Just lately, though, this mechanism hasn't worked well, because the financial crisis has broken the transmission mechanism at the step of &quot;the banks lend more money&quot;--the banks are bust, so they're not lending, consumers are bust so they're not borrowing (and the ones who would borrow are poor risks for paying the money back), and businesses staring into the economic abyss are not borrowing either.</p> <p>Faced with that problem, the Fed has now brought out the big guns.&nbsp; Last week the Fed <a href="http://www.federalreserve.gov/newsevents/press/monetary/20090318a.htm">announced that it was going to buy</a> &quot;up to $300 billion of longer-term Treasury securities over the next six months.&quot;&nbsp; Because here's the thing--there's one entity that can and will do the necessary borrowing and spending to produce inflation:&nbsp; The US Treasury.</p> <p>That $300 billion, plus another $1.55 trillion spent on US government agency securities, are guaranteed to work their way through the economy and produce some inflation, pretty much ending the risk of deflationary collapse.</p> <p>The questions then become, &quot;How much inflation?&quot; and &quot;What next after that?&quot;</p> <h2>How much inflation?</h2> <p>Nobody knows.&nbsp; It's impossible to even guess.&nbsp; The Fed's governors and the presidents of the individual reserve banks do make projections (for what they're worth, they <a href="http://www.federalreserve.gov/monetarypolicy/fomcminutes20090128ep.htm">recently projected </a>inflation of 0.3% to 1.0% in 2009 and 1.0% to 1.5% for 2010), but their projections are no more accurate than anyone else's--which is to say not accurate at all.</p> <p>It's easy to say what they're trying to do.&nbsp; They're trying to offset the deflationary impact of the financial crisis.&nbsp; And, because they know how to stop inflation, they're willing to aim a bit high--they want to be sure that they're <strong>entirely</strong> offsetting the deflationary impact, and they're willing to risk an accidental inflationary surge.&nbsp; They view the downside risk in that direction as much smaller than the downside risk of an accidental deflationary spiral.</p> <p>The problem is that they could easily overshoot much too high, producing inflation on a scale that trashes the whole economy.&nbsp; (Inflation of just 10% wreaks drastic havoc with a modern economy.&nbsp; It becomes impossible to make any sort of long-term plan, because there's no way to know what the money will be worth a few years down the road.)</p> <h2>What next after that?</h2> <p>Yes, the Federal Reserve knows how to stop inflation--by causing a recession.&nbsp; Of course, we've already got a recession.&nbsp; Unfortunately, the process doesn't work in reverse:&nbsp; Being in a recession doesn't prevent the next round of inflation.</p> <p>What we're looking at now is ameliorating this recession with a burst of inflation, in the hopes that doing so will keep it from turning into a depression.&nbsp; At that point things can go one of three directions:</p> <ol> <li>The inflationary burst falls short and the deflationary spiral continues in earnest&nbsp; (The Fed's latest move signals that they'll do whatever it takes to prevent this scenario.)</li> <li>The inflationary burst is &quot;just right,&quot; halting the deflationary spiral without pushing inflation up to levels that threaten the economy.&nbsp; (This is what the Fed is trying to do.&nbsp; Let's all wish them luck.)</li> <li>The inflationary burst is excessive, producing a serious bout of inflation.&nbsp; (There really isn't an upper bound here.&nbsp; Just a few percent does serious harm to the economy, but 10%, 50%, 10,000% and more have all been seen in various places around the world, over and over again since the invention of paper money.&nbsp; In 1979 and 1980 the US saw inflation rates over over 1% per month, which is plenty to wreck individual household budgets.)</li> </ol> <p>If the inflationary burst turns out to be excessive, the Fed will reduce the rate of growth in the money supply to bring it back down, but we know what that does--it produces a recession.&nbsp; Maybe that recession will be different from this one--specifically, maybe it won't come hand-in-hand with a collapsing financial system--in which case maybe the Fed will stick to its guns and grind the inflation rate back down low enough that its economic effects are minor.&nbsp; But I don't see much reason for optimism.&nbsp; First, we'd have to fix the financial system between now and then--and there hasn't been much progress on that front so far.&nbsp; Second, a solid majority of the policy-setting Federal Open Market Committee members would have to grow a pair, and I'm not too hopeful about that either.&nbsp; The upshot is that I foresee inflation followed by a half-hearted attempt to rein in money supply growth, followed by more inflation.</p> <p>And, to bring things full circle, we know where that leads.&nbsp; If you want stagflation, all you need to do is try to bring down inflation and then cave in at the first signs of recession.&nbsp; Kick the inflation rate up nice and high first and you can legitimately call it stag-hyperinflation.</p> <br /><div id="custom_wisebread_footer"><div id="rss_tagline">This article is from <a href="http://www.wisebread.com/philip-brewer">Philip Brewer</a> of <a href="http://www.wisebread.com/stag-hyperinflation">Wise Bread</a>, an award-winning personal finance and <a href="http://www.wisebread.com/credit-cards">credit card comparison</a> website. Read more great articles from Wise Bread:</div><div class="view view-similarterms view-id-similarterms view-display-id-block_2 view-dom-id-3"> <div class="view-content"> <div class="item-list"> <ul> <li class="views-row views-row-1 views-row-odd views-row-first"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/inflation-is-going-away-for-a-while">Inflation is going away for a while</a></span> </div> </li> <li class="views-row views-row-2 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/preparing-for-a-recession">Preparing for a Recession</a></span> </div> </li> <li class="views-row views-row-3 views-row-odd"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/living-within-your-means-isnt-nasty">Living within your means isn&#039;t nasty</a></span> </div> </li> <li class="views-row views-row-4 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/oh-noes-inflation">Oh noes! Inflation!</a></span> </div> </li> <li class="views-row views-row-5 views-row-odd views-row-last"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/how-to-live-with-inflation">How to live with inflation</a></span> </div> </li> </ul> </div> </div> </div> </div><br/></br> Personal Finance depression Economy Fed federal reserve Great Depression hyperinflation inflation recession stagflation Tue, 24 Mar 2009 16:15:48 +0000 Philip Brewer 2970 at http://www.wisebread.com Inflation is going away for a while http://www.wisebread.com/inflation-is-going-away-for-a-while <div class="field field-type-filefield field-field-blog-image"> <div class="field-items"> <div class="field-item odd"> <a href="/inflation-is-going-away-for-a-while" class="imagecache imagecache-250w imagecache-linked imagecache-250w_linked"><img src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/imagecache/250w/blog-images/rocky-beach.jpg" alt="Rocky beach" title="Rocky Beach" class="imagecache imagecache-250w" width="250" height="315" /></a> </div> </div> </div> <p>For a decade, starting in the mid-1990s, the Federal Reserve kept interest rates too low and expanded the money supply too quickly.  Their theory was that, as long as consumer prices were stable, they must not be creating too much money.  We now know that they were wrong.</p> <p>Confused by the way globalization held down consumer prices, the Fed printed us up a metric truckload of inflation.  It showed up in house prices, stock prices, oil prices, grain prices--pretty much all prices except the prices of stuff made in low-wage countries and imported into the United States.  Unfortunately, those prices are a major component of the CPI--and particularly of the <a href="/the-core-rate-is-not-an-evil-conspiracy">&quot;core&quot; CPI</a> (consumer prices excluding food and energy).</p> <p>Starting in late 2006 and accelerating in late 2007, though, that inflation started spilling into consumer prices as well.</p> <p>The US (both the government and individuals) had borrowed huge amounts of money.  Between that and the rising inflation, holders of dollars were beginning to think that maybe they didn&#39;t want all their cash in dollars. That put downward pressure on the value of the dollar, which pushed up the prices of just about everything (because the US imports just about everything).  Prices soared--oil, wheat, milk, corn, anything traded globally got more expensive:  This was a decade of excessive money creation by the Fed finally showing up in prices.</p> <p>Just as this was happening, though, the Federal Reserve seemed to lose its mind.  Instead of raising interest rates to curb inflation, it started cutting rates.  Pointing to the &quot;core&quot; rate of inflation, which barely budged, the Fed suggested that deflation was a bigger worry than inflation.</p> <p>The verdict is still out on that, but there&#39;s some new evidence that the Fed is right.</p> <p>First, prices of global commodities are falling.  In just the past few months:</p> <ul> <li><a href="http://tonto.eia.doe.gov/dnav/pet/hist/wtotworldw.htm">Crude oil down 28%</a> </li> <li><a href="http://www.ers.usda.gov/Data/Wheat/YBtable18.asp">Wheat down 24%</a> </li> <li><a href="http://future.aae.wisc.edu/data/monthly_values/by_area/21?tab=prices">Non-fat dry milk down 14%</a> </li> </ul> <p>So, what&#39;s going on?  There are several forces at work, and they&#39;re currently feeding back into one another.</p> <h2>US as a safe haven</h2> <p>The same people who had decided that, in view of the US trade deficit and budget deficit, they didn&#39;t want to hold so many dollars have changed their tune.  If the economy is going to melt down, maybe the US isn&#39;t such a bad place to have some wealth.  The US has a strong tradition of sound banks and other financial institutions.  In addition, it has seemed much more willing these past few weeks to take aggressive action to protect its financial system than some other countries. </p> <p>With more demand for the dollar, it has been rising against foreign currencies.  A stronger dollar means lower dollar prices for global commodities.</p> <h2>Leverage</h2> <p>During the huge spike in commodities, many investors piled on, trying to make money on what was obviously a long-term upward trend.  Many of them did so with borrowed money--and many thought that the dollar would be the cheapest currency to borrow, because dollar interest rates were low and the dollar was falling.</p> <p>Now, with the dollar rising, many of those investors are moving to unwind those transactions--selling their commodities so they can pay off their dollar debts now, before the dollar moves even higher.  That pushes commodities down and the dollar up.</p> <h2>Economic slowdown</h2> <p>Less business activity means less demand for basic commodities, leading directly to lower prices.</p> <p>Producers of basic commodities will obviously see lower profits.  Other businesses are facing lower profits as well, even though some of their inputs are shaping up to be cheaper, simply because of falling demand due to the general economic slowdown.</p> <p>Notice that these forces emphasize one another--any sort of economic stress makes the safe-haven aspect of the US look more attractive, anything that makes the US look more attractive raises the value of the dollar, and a higher dollar pushes down the price of commodities, producing more economic stress, and so on.</p> <h2>What about inflation?</h2> <p>Just as higher commodity prices looked like <a href="/more-than-just-inflation">inflation</a>, lower commodity prices look like deflation.</p> <p>I think there&#39;s a long-term trend toward higher commodity prices, simply because rising demand inevitably runs up against limited resources--oil, fresh water, arable land, etc.  Because of that, I think declines in commodity prices are going to be temporary.  Even so, prices might stay down for a considerable period, if the economy remains stressed for a considerable period.</p> <p>I was one of those who, a few months ago, thought the Fed had lost its mind.  Cutting interest rates just as inflation was spiking up to generational highs seemed like exactly the wrong policy.  I&#39;ve changed my mind.  I certainly don&#39;t know if the Fed&#39;s policy is the right one, but I no longer think it&#39;s an insane one.</p> <p>Vast amounts of &quot;money&quot; have simply disappeared:  the illusory wealth of the housing bubble, the mortgage-backed securities based on it, and the paper assets based on those.  The destruction of that &quot;money&quot; is hugely deflationary.  The Fed is trying to create enough money to offset that destruction.  The problem is that they have no way to know how much money to create.  They&#39;re walking a tightrope, with a deflationary depression on one side and hyperinflation on the other.</p> <p>The Fed is clearly inclined to err on the side of inflation, simply because they know how to cure inflation.  Only incredible luck would produce a soft landing at this point.  The Fed is aiming to produce a modest amount of inflation--confident that, if it manages that, it can bring the inflation back down once the economy is out of danger.  In the short term, though, I think the risk of inflation has fallen quite a bit, simply because so many people want to hold dollars.</p> <p>Since the Fed is trying to create some inflation, I don&#39;t expect this situation to persist for long--I wouldn&#39;t get rid of your inflation hedges--but don&#39;t enter into transactions expecting inflation to bail you out, and don&#39;t be surprised if we see some of the price hikes of the past few months suddenly reversed.</p> <p>It&#39;s a scary situation, and it&#39;s not very comforting to realize that the central bankers are just as scared as we are.</p> <br /><div id="custom_wisebread_footer"><div id="rss_tagline">This article is from <a href="http://www.wisebread.com/philip-brewer">Philip Brewer</a> of <a href="http://www.wisebread.com/inflation-is-going-away-for-a-while">Wise Bread</a>, an award-winning personal finance and <a href="http://www.wisebread.com/credit-cards">credit card comparison</a> website. Read more great articles from Wise Bread:</div><div class="view view-similarterms view-id-similarterms view-display-id-block_2 view-dom-id-4"> <div class="view-content"> <div class="item-list"> <ul> <li class="views-row views-row-1 views-row-odd views-row-first"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/stag-hyperinflation">Stag-hyperinflation?</a></span> </div> </li> <li class="views-row views-row-2 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/oh-noes-inflation">Oh noes! Inflation!</a></span> </div> </li> <li class="views-row views-row-3 views-row-odd"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/how-to-live-with-inflation">How to live with inflation</a></span> </div> </li> <li class="views-row views-row-4 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/more-than-just-inflation">More than just inflation</a></span> </div> </li> <li class="views-row views-row-5 views-row-odd views-row-last"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/preparing-for-a-recession">Preparing for a Recession</a></span> </div> </li> </ul> </div> </div> </div> </div><br/></br> Personal Finance central banks commodities depression Fed federal reserve inflation recession Wed, 08 Oct 2008 15:14:20 +0000 Philip Brewer 2502 at http://www.wisebread.com Possible protections for credit card holders http://www.wisebread.com/possible-protections-for-credit-card-holders <div class="field field-type-filefield field-field-blog-image"> <div class="field-items"> <div class="field-item odd"> <a href="/possible-protections-for-credit-card-holders" class="imagecache imagecache-250w imagecache-linked imagecache-250w_linked"><img src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/imagecache/250w/blog-images/credit-cards_1.jpg" alt="Credit cards" title="Credit Cards" class="imagecache imagecache-250w" width="250" height="178" /></a> </div> </div> </div> <p>The Federal Reserve has proposed some new rules to protect people from a list of abusive lending practices.  The changes aren&#39;t in effect yet, and may not actually go into effect.  It&#39;s worth looking at the proposals, though, to understand what&#39;s been going on just lately.  If you haven&#39;t been paying attention, you probably have no idea what the credit card companies can legally do to you.</p> <p>The things that would be prohibited would be:</p> <h2>Increasing the rate on a pre-existing balance</h2> <p>At the moment, there are pretty much no rules about this.  Your card agreement probably says how they calculate the rate--but it also says that they can change the agreement at any time, including the part on how to calculate the rate.  Many card agreements also provide for you to &quot;decline&quot; to accept changes--but if you use the card after they send out the notice of changes, that&#39;s the same as accepting the new agreement.  And some cards don&#39;t even offer that protection--they can raise the rate for any reason, or for no reason at all, and there&#39;s nothing you can do about it except pay the new rate until you manage to get the debt paid off.</p> <h2>Applying payments to maximize the interest charges</h2> <p>Your credit card agreement says how they&#39;ll apply any payment that you send in.  It matters, because parts of your balance are at different rates.  If you read the details, things are often set up to pay off low-rate parts of the debt first, leaving you paying on high rate debt for as long as possible.  Under the new rules:</p> <blockquote><p>Banks would be required to give consumers the full benefit of discounted promotional rates on credit cards by applying payments in excess of the minimum to any higher-rate balances first, and by providing a grace period for purchases where the consumer is otherwise eligible.</p></blockquote> <h2>Imposing interest charges using the &quot;two-cycle&quot; method</h2> <p>The &quot;two-cycle&quot; method is a set of rules for calculating the interest owed in such a way that you don&#39;t get any &quot;grace period&quot; if you don&#39;t pay your card off in full every month.  If you carry a balance all the time, it doesn&#39;t matter.  But if you <strong>usually</strong> pay your card off, but <strong>occasionally</strong> take an extra month to get back to zero, the two-cycle method can very nearly double the interest you pay.</p> <p>The rules would also require that banks give card holders a &quot;reasonable&quot; amount of time to make payments.  It used to be that card holders got almost 30 days--basically, you had until the day they printed out your next bill.  Credit card companies, though, have been shortening the grace period, especially for their riskier customers.  For some cards, it&#39;s gotten to the point where you really have to stay on top of your bills every day, in order not to be constantly late on your payment.</p> <p>Of course, the only sensible thing to do with credit cards is to pay them off every month.  Credit cards are a great <strong>payment mechanism</strong>, but a terrible way to borrow money.  Everybody knows that.  And these new rules wouldn&#39;t really offer much to the people who do use their credit cards to borrow money.  </p> <p>What these new rules would do is protect people who fail to run an error-free bill-paying and agreement-reading system.  As things stand right now, someone who pays every bill in-full, but who is only 99% successful at paying on-time, could easily end up owing hundreds of dollars in fees, penalties, and interest.  These rules would ease up some of the worst of the &quot;gotcha&quot; effect.  (And it certainly seems that some banks have been changing their rules specifically to set their customers up to make occasional small errors--and turn those errors into big fees for the bank.)</p> <p>The rules are open for public comment.  No doubt the big banks will be commenting.  They&#39;ll have statistics that show that customers who make a late payment are much more likely to default than customers who are never late.  Maybe a few consumers will comment about the basic unfairness of agreements that the credit card companies can change at any time.</p> <p>Links to the detailed rules and on how to comment are in the Federal Reserve&#39;s press release on <a href="http://www.federalreserve.gov/newsevents/press/bcreg/20080502a.htm">rules to prohibit unfair practices</a>.</p> <br /><div id="custom_wisebread_footer"><div id="rss_tagline">This article is from <a href="http://www.wisebread.com/philip-brewer">Philip Brewer</a> of <a href="http://www.wisebread.com/possible-protections-for-credit-card-holders">Wise Bread</a>, an award-winning personal finance and <a href="http://www.wisebread.com/credit-cards">credit card comparison</a> website. Read more great articles from Wise Bread:</div><div class="view view-similarterms view-id-similarterms view-display-id-block_2 view-dom-id-2"> <div class="view-content"> <div class="item-list"> <ul> <li class="views-row views-row-1 views-row-odd views-row-first"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/can-your-spending-patterns-affect-your-credit">Can Your Spending Patterns Affect Your Credit?</a></span> </div> </li> <li class="views-row views-row-2 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/do-we-really-need-help-in-getting-more-debt">Do we really need help with getting more debt?</a></span> </div> </li> <li class="views-row views-row-3 views-row-odd"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/new-credit-card-legislation-buzz-interview-wall-street-journal">New Credit Card Legislation Buzz: An Interview with Wall Street Journal’s Mary Pilon</a></span> </div> </li> <li class="views-row views-row-4 views-row-even"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/easy-ways-to-save-on-7-everyday-buys">Easy Ways to Save on 7 Everyday Buys</a></span> </div> </li> <li class="views-row views-row-5 views-row-odd views-row-last"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/netspend-the-story-of-the-visa-debit-card-we-did-not-apply-for">netSpend: The Story of the Visa Debit Card We Did Not Apply For</a></span> </div> </li> </ul> </div> </div> </div> </div><br/></br> Consumer Affairs Credit Cards bank regulations credit card agreements credit cards Fed federal reserve regulations Tue, 20 May 2008 15:56:53 +0000 Philip Brewer 2106 at http://www.wisebread.com Federal Reserve cuts the discount rate http://www.wisebread.com/federal-reserve-cuts-the-discount-rate <div class="field field-type-filefield field-field-blog-image"> <div class="field-items"> <div class="field-item odd"> <a href="/federal-reserve-cuts-the-discount-rate" class="imagecache imagecache-250w imagecache-linked imagecache-250w_linked"><img src="http://wisebread.killeracesmedia.netdna-cdn.com/files/fruganomics/imagecache/250w/blog-images/frb-new-york.jpg" alt="" title="" class="imagecache imagecache-250w" width="250" height="306" /></a> </div> </div> </div> <p>In response to the recent <a href="/credit-squeeze-formerly-know-as-a-panic">credit squeeze</a>, the Federal Reserve did something unusual: they <a href="http://www.federalreserve.gov/boarddocs/press/monetary/2007/200708172/default.htm">cut the discount rate</a> without cutting the federal funds rate.</p> <p>The federal funds rate is the rate at which banks lend to one another. The discount rate is the rate at which the Fed itself will lend money to banks. For the past few years, the Fed has closely coordinated changes in these rates, so to change one without changing the other is a departure.</p> <h2>Interesting history of fed funds and discount rate<br /></h2> <p>Until the late 1960s the discount rate acted as a ceiling on the fed funds rate. The logic was that a bank that needed reserves could always get them from the Fed, so the only reason that it would pay more than the discount rate would be if it had tried to borrow from the Fed and been turned down--which would only happen if the bank were not sound. </p> <p>In the late 1960s, though, things changed. Banks had profitable business opportunities that the Fed was disinclined to support. To get the reserves they needed, they went ahead and bid up the fed funds rate. From that point until 2003, the fed funds rate was generally higher than the discount rate. Of course, that made borrowing at the discount rate attractive--cheap funds make for more bank profit. The Fed rationed the funds through moral suasion--by asking uncomfortable questions and making it clear that the discount window was for emergencies and special situations, not as a source of cheap funds for higher profits.</p> <p>The Fed was never really happy with rationing discount borrowing through moral suasion. In 2003 it changed the rules, setting the discount rate above the fed funds rate, and promising that the uncomfortable questions would end. Since the rate was above the market rate, there was no need to ration funds, and because the whole purpose of the Fed was to stand behind sound banks, any sound bank that was suffering some sort of temporary embarrassment in borrowing reserves would have access to ample funds.</p> <h2>How the discount window works</h2> <p>The <a href="http://www.frbdiscountwindow.org/">discount window</a> got its name because it used to work by &quot;discounting&quot; loans. The bank would show up at the window with some sound loans to its customers and sell them to the Fed at a discount--with the proceeds going to augment the bank&#39;s reserves. Transactions today are usually treated as a loan from the Fed to the bank, but they are still collateralized with bank assets, which can include customer loans. </p> <p>The goal is to ensure that the banks can keep lending money to good credit risks, even when credit conditions tighten up. Nowadays banks make large loans expecting to sell them to investors. During a credit squeeze, the market for reselling loans can dry up. With so much of its money tied up in large loans that they can&#39;t sell, the bank would have to stop lending. But, with access to the discount window, the bank can essentially sell the loan (temporarily) to the Fed, allowing it to continue doing business until credit conditions return to normal.</p> <p>In that sense, things are working exactly as they should.</p> <h2>Sensible move</h2> <p>In my view, this is a sensible move by the Fed. By keeping the federal funds rate stable, they&#39;re avoiding the &quot;moral hazard&quot; of bailing out people who made risky investments. By lowering the discount rate, they&#39;re making sure that banks can continue doing business, even during a credit squeeze.</p> <p>Since very little money is actually borrowed at the discount window (even with the cut, the rate is still above the fed funds rate, making it an unattractive source of funds), the impact on the real economy is small, and yet it shows that the Fed is taking the situation seriously. That has calmed markets some, without doing much harm in terms of boosting inflation or bailing out the big risk-takers. </p> <h2>Ordinary investors and borrowers</h2> <p>The move doesn&#39;t have much implications for ordinary investors and borrowers. Most of your interest rates--even the floating rates--aren&#39;t tied to the discount rate.</p> <p>If you have money that you&#39;ve borrowed at floating rates, check to see what the rate is pegged to--the prime rate is common, but there are other base rates--and make a point of keeping an eye on that rate. So far the prime rate hasn&#39;t changed, and the Fed&#39;s action seems to suggest that it won&#39;t let these problems force rates higher, but you should still monitor the situation. </p> <br /><div id="custom_wisebread_footer"><div id="rss_tagline">This article is from <a href="http://www.wisebread.com/philip-brewer">Philip Brewer</a> of <a href="http://www.wisebread.com/federal-reserve-cuts-the-discount-rate">Wise Bread</a>, an award-winning personal finance and <a href="http://www.wisebread.com/credit-cards">credit card comparison</a> website. Read more great articles from Wise Bread:</div><div class="view view-similarterms view-id-similarterms view-display-id-block_2 view-dom-id-2"> <div class="view-content"> <div class="item-list"> <ul> <li class="views-row views-row-1 views-row-odd views-row-first"> <div class="views-field-title"> <span class="field-content"><a href="http://www.wisebread.com/oh-noes-inflation">Oh noes! 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