Results are out! Find what you need...fast. Get quick advice or join the chat
Hey there! Sign in to have your say on this topicNew here? Join for free to post

Interest Rates

Announcements Posted on
Become part of the Welcome Squad! Apply here! 28-10-2014
    • Thread Starter
    • 0 followers
    Offline

    ReputationRep:
    Can someone help me understand as much about interest rates as possible please:
    How does the central bank set interest rates?
    What effect does it have to adjust the rates?
    How does it relate to the interest rates of loans in general in the country?
    How would interest rates be set by the market if the central bank was not in control? And what are the benefits or negatives of setting interest rates by the bank vs allowing the market to determine them?

    Thank you for any help. It is really appreciated.
    • 8 followers
    Offline

    ReputationRep:
    The central bank sets the interest rate at which it lends to other banks. This acts as a control upon the average interest rates.

    What would happen without the central bank? Hard to say, because interest is almost always influenced by some sort of state intervention in the matter, i.e. before (and for a bit after) the Federal Reserve was formed in the US, the country was on a state-mandated gold standard, which obviously would be have different effects to an entirely paper based one like we have now.
    • Thread Starter
    • 0 followers
    Offline

    ReputationRep:
    (Original post by anarchism101)
    The central bank sets the interest rate at which it lends to other banks. This acts as a control upon the average interest rates.
    So if currently the interest rate being set is lower than inflation, then the central bank is lending to other banks at a loss? What are the effects of this and where do they get the money to lend - by inflating the money supply?

    (Original post by anarchism101)
    What would happen without the central bank? Hard to say, because interest is almost always influenced by some sort of state intervention in the matter, i.e. before (and for a bit after) the Federal Reserve was formed in the US, the country was on a state-mandated gold standard, which obviously would be have different effects to an entirely paper based one like we have now.
    So I guess without having money linked to something such as gold then we have to have a central bank to control the money supply? If we had a gold standard, then would it be the case that any bank can print money assuming it has the gold deposits to back this up?
    • 8 followers
    Offline

    ReputationRep:
    (Original post by Раскольников)
    So if currently the interest rate being set is lower than inflation, then the central bank is lending to other banks at a loss? What are the effects of this and where do they get the money to lend - by inflating the money supply?
    Pretty much yeah. Central banks generally have the power to simply create money - though it's worth noting that in our current fractional reserve system, all banks have this power to a degree. The difference is that while both normal banks and the central banks can create money out of thin air for the purpose of lending, the central bank can also do it for the purpose of purchasing assets.

    With this in mind, central banks can't really run 'at a loss' as such. Though in lending, many of them do lend out actual money, because all the other banks have to have a certain amount of reserve at the central bank in order to create money for lending (in the US, for example, banks are only allowed to create for loans 10 times as much as they have in reserves at the Fed).

    So I guess without having money linked to something such as gold then we have to have a central bank to control the money supply? If we had a gold standard, then would it be the case that any bank can print money assuming it has the gold deposits to back this up?
    Not necessarily. It should be noted that even during the gold standard, people rarely actually used gold in everyday transactions, they used notes with promises to pay certain amounts of gold. That's essentially what money is - a promise to provide something of real value. What it is now is a promise from the government that it will cancel part of your debts and tax bills.

    The difference between gold and what we currently have is that the gold supply doesn't expand much. I'll try and explain;

    As I mentioned above, to create money for lending, banks have to have a certain amount of already-existing 'real' money in reserve at the central bank. But when a bank creates new money in a loan, that money has the same standing as any of the already existing 'real' money, meaning another bank can deposit it as reserves at the central bank. There is no limit to the amount of money that can be created this way.

    If the system were exactly the same, but with gold, then there is a limit to the amount of reserves, as there's a limited supply of gold.

    My personal opinion, however, is that fractional reserve banking is fundamentally flawed regardless of whether we use gold in it or not.
    • 2 followers
    Offline

    ReputationRep:
    (Original post by anarchism101)
    My personal opinion, however, is that fractional reserve banking is fundamentally flawed regardless of whether we use gold in it or not.
    Yep.
    • Thread Starter
    • 0 followers
    Offline

    ReputationRep:
    (Original post by anarchism101)
    If the system were exactly the same, but with gold, then there is a limit to the amount of reserves, as there's a limited supply of gold.

    My personal opinion, however, is that fractional reserve banking is fundamentally flawed regardless of whether we use gold in it or not.
    I guess if the bank was to have 100% reserves then you have to pay them to look after your money, as they have no way to lend it out and make interest on loans and therefore cannot also give you interest? Would it be possible to have a system where a bank can choose to have a certain amount of reserves, say 10%, but only allows a depositor to withdraw that same fraction within a given time period? That way it would be possible for savings to be used for investing, but without the risk of a run on the banks. And then people could presumably choose what fraction they want depending on how much they value the interest on their deposit vs the ability to have easy access to their money.

    If that could work, I don't know whether or not that would have any implications about whether there should be a gold-standard and what role the central bank should have. A lot of stuff left for me to learn :/
    • 34 followers
    Offline

    ReputationRep:
    (Original post by Раскольников)
    I guess if the bank was to have 100% reserves then you have to pay them to look after your money
    Probably not. Banks would probably look after your money for free, so that you like them and then will allow them lend out your money. They might charge, they might not. As money would likely be digital the cost of looking after it would likely be so small that they need not charge to look after your money.

    It would not be like in the olden days when money was an actual commodity and need a small fort to protect it and loads of armed guards.

    say 10%, but only allows a depositor to withdraw that same fraction within a given time period?
    That is full reserve banking. The depositer is legally entitled to money that is actually in the bank and can access it at any time.

    That way it would be possible for savings to be used for investing, but without the risk of a run on the banks. And then people could presumably choose what fraction they want depending on how much they value the interest on their deposit vs the ability to have easy access to their money.
    Correct.

Reply

Submit reply

Register

Thanks for posting! You just need to create an account in order to submit the post
  1. this can't be left blank
    that username has been taken, please choose another Forgotten your password?
  2. this can't be left blank
    this email is already registered. Forgotten your password?
  3. this can't be left blank

    6 characters or longer with both numbers and letters is safer

  4. this can't be left empty
    your full birthday is required
  1. By joining you agree to our Ts and Cs, privacy policy and site rules

  2. Slide to join now Processing…

Updated: May 15, 2012
New on TSR

Halloween 2014

Join the TSR Halloween party...if you dare!

Article updates
Useful resources
Reputation gems:
You get these gems as you gain rep from other members for making good contributions and giving helpful advice.