The Fed’s New Interest Rate Forecasts

You may have heard that the Federal Reserve will be releasing a new form of  interest rate forecasts starting with Wednesday’s policy meeting.  FT Alphaville has a great Q&A on what the Fed is trying to accomplish, and reasons why it may or may not work.

The entire Q&A is worth a read.

-KD

ps – the Fed’s goal here is something that was always kinda counter-intuitive to me.  In essence, I disagree with the theory that placating market assumptions about interest rates in the future – reassuring the market that rates will stay low for a long time –  will make it more likely for people to want to borrow NOW.  Let me explain:  right now, one appealing factor of home buying/selling decisions is that interest rates are very low – you can afford to buy more house.   If I think that interest rates are going to remain low for a long period of time, I will be in no hurry to lock in this low rate on the debt I’m borrowing – I will be in no hurry to go out and buy a house….. Same for issuing fixed rate debt:  if I’m a company looking to expand and I think interest rates will be going higher, I have more incentive to borrow money NOW, at this low rate.   But if the Fed assures me that rates will be low for a long time, then I have no reason to rush my borrowing (and subsequent spending) plans.   It seems to me that by assuring the Market that rates will be low for a long period of time, the Fed is giving borrows an excuse to NOT borrow (and thus not spend) now with any sense of urgency.

Let me give you another example:  we all know that a marketing ploy for sales of all types (furniture, electronics, cars) is to promise low financing rates if you buy now – buy now, and you’ll lock in this low rate.  But if you have low financing rates all the time, or at least for the foreseeable future, you remove incentive to “BUY NOW.”

 

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