Interest Rates




Interest rates have frequently been proposed as a guide to policy, not only because of the role they play in a wide variety of spending decisions but also because information on interest rates is available on a real time basis. Arguing against giving interest rates the primary role in guiding monetary policy is uncertainty about exactly what level or path of interest rates is consistent with the basic goals of monetary policy. The appropriate level of interest rates will vary with the stance of fiscal policy, changes in the pattern of household and business spending, productivity growth, and economic developments abroad. It can be difficult not only to gauge the strength of these forces but also to translate them into a path for interest rates.
The difference between the interest rate on longer term and shorter term instruments has also been suggested as a guide to monetary policy. Whereas short-term interest rates are strongly influenced by the current setting of the policy instrument, longer term interest rates are influenced by expectations of future short term interest rates and thus by the longer term effects of monetary policy on inflation and output. For example, longer term interest rates far above short term rates may be a signal that participants in the bond market believe that monetary policy has become too expansive and thus, without a monetary policy correction, more inflationary. Conversely, short term rates above longer rates may be an indication that policy is too restrictive, perhaps risking an unwanted loss of output and employment. Other factors include prospective fiscal policy, developments in foreign exchange markets, and expectations about the future path of monetary policy.

 

Back

 

Back to Test