The interest rate, which is determined by the Federal Reserve Bank (FED), is one of the most respected interest rate in the world. Justified by the overall influence of the economy of the United States, which Gross Domestic Product (GDP) is about 15% of the world wide GDP. But since several years, it is declining (2005 over 21%) and now is China leading with a portion of approximately 17% and still climbing.
Did you know which country stands at number 3?
If you expect Japan (4.2%) , Germany (3.4%) or Russia (3.1%), you are wrong. Number three is India with a share of 7%. Interesting, isn´t it?
Federal reserve historical interest rates
The image contains also the official recessions in the United States. As you can see in every recession the FED lowered the interest rate. Before the eighties the FED raise the interest rate outside the recession. After the interest peak in 1981 the long term trend is falling.
After the recession in the nineties and the following boom the behave a little different than all the time before. Instead constantly rising interest rates they stopped it and the interest rates stall at about 5%. May be you remember: Alan Greenspan was from 1987 until January 2006 chief of the FED. In 2000 burst the Dotcom bubble and as in every recession the FED reduced the interest rates.
In the following year the economy recovered and the FED increased steadily the interest rates until the financial crises occurred with the bankruptcy of Lehman Brothers, the takeover of StearBeans, the problems with AIG, Freddie Mac and Fannie Mae. This crisis spread all over the world and many countries are still suffering.
Federal reserve historical real interest rates
If you look at the interest rates, you want to know the “real” interest rates, i.e. what is the interest rate after inflation. A measure of inflation is the Consumer Price Index (CPI). To learn a little more about this concept and the problems, take a look at my article: “Inflation rates last 10 years“.
The black line is the Consumer Price Index for All Urban Consumers: All Items, Index 1982-1984=100, Seasonally Adjusted with the percent change from a year ago.
The green line is the Effective Federal Funds Rate minus the above mentioned CPI.
Interesting to see, that in the seventies in combination with the strong rise of the oil price, although the interest rates were high, the real interest rate was negative. Even in the beginning eighties, when we saw the highest Federal Funds Rate ever, the real interest rate was negative.
Today, nearly seven years without an official recession, the Federal Funds Rate is still near zero and the real interest rate is since the financial crisis negative.
Why is reducing the FED the interest rates in a recession?
The economic theory says, that the interest rate is connected to the growth of a country. Low interest rates mean, that companies will borrow money, invest in machines, software and / or products and offer these additional products to customers.
In a boom the FED starts to increase the interest rate and the companies calculate their investing with the higher interest rate. Some of them decide, that borrowing money is too expansive and that the investment will not bring additional money. Therefore they stop producing additional products and the boom ends.
The task of the FED is to reach and maintain an equilibrium. Obviously this is in real life a complex task and it works approximately, depending on the point of view.
The FED: Private or Public?
Some people argue, that the Federal Reserve Bank is despite the name “Federal” a private institution. Because of this, they have a private agenda and don´t act in the best manner for the American people.
The twelve Federal Reserve Banks are stock companies. The owner are the local banks, but they have different rights than normal stock owners. They can not give or sell the shares to other people or companies. The board is not elected by the owners, instead they are nominated by the government.
The shareholder gets dividendpayments, but in relation to normal companies, it is peanuts. For example, in 2011 the owner got $1.6 billion but the government got $78 billion.
The FED calls himself as an “independent entity within the government”. The Federal Reserve Bank of St. Louis says very shortly: “The answer is both”.
Despite the low interest rate and the fact that the real interest rate is not negative at the moment, I´m not happy with the situation. In the next recession, which will come, the FED lowers the interest rate again. But the outcome of the real economy is low and they have to lower it below zero. This leads to an unknown land. Does it make me happier or does it lead to new problems?
I will discuss this topic in another article. Stay tuned.
As you can see over the years we had worse real interest rates than today. But you have to take care with your capital and invest it wisely. Trading could be one possibility.
I hope, you gained some information. I’m more than happy to answer your questions.