How Low Interest Rates and the Federal Reserve Affect Our Economy

The Federal Reserve has decided to keep short term interest rates near zero, until at least the end of 2014, in hopes of encouraging Americans to borrow by making it easier to get more money to spend and invest. Obviously, our economy is still in the dumps, and unemployment still seems to be a problem, yet many people still argue in favor of keeping interest rates low.

Learn Liberty, a project of Institute for Humane Studies, has uploaded a great video called “Are Low Interest Rates Good?” on YouTube. In the video, Prof. Davies explains that low interest rates may seem beneficial to borrowers, but are actually harmful to savers because they earn a lower rate on their savings.

Davies effectively refutes the low interest rate argument by stating that low interest rates only increase spending now, in exchange for less spending later. Higher interest rates don’t discourage people from spending. It simply encourages them to spend less now, in exchange for spending more in the future.

According to Prof. Davies, in 1972, the average mortgage rate was at 7%, and the average household debt was at 76%. Now, compare those statistics with 2010’s low interest mortgage rates of 4.7% and the average household debt of 132%. What could be inferred is that the low interest rates in 2010 allowed families to borrow twice as much as what they could afford, leaving them in debt. The video proves that the problem is simple: low interest rates have made the economy and the housing market unbearable for many Americans.

So while the choice may seem to come down to low interest rates versus higher interest rates, Professor Davies concludes that the best solution is for the free market to determine interest rates. In order to help the economy, the Federal Reserve should not interfere with the markets by keeping interest rates artificially low.

Interest rates should be determined by individuals, acting within the free market, deciding whether to spend more and save less or save for the future and spend less now - not by central planners acting within the Federal Reserve System. http://www.youtube.com/watch?v=4SNVx7Nl65M

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