We hear a lot about interest rates, and not only in my professional field of expertise. Interest rates are everywhere to be found in our daily lives: credit card interest, interest on deposits, car loan interest, personal loan interest, treasury bond interest. The other day I received a spam e-mail that said: “Need new socks ? Apply for our Family Loan – competitive interest rates”. Since I am single and own approximately fifty pairs of socks – they seem to be the preferred Christmas present in my household – I decided not to push the ‘Click Here’ button. But just what are the mechanics of interest rate setting? Who decides which interest rate to charge to whom – and how?
Paul Volcker, while chairman of the Board of Governors of the Federal Reserve System (1979-87), was often called the second most powerful person in the United States. Volcker triggered the “double-dip” recessions of 1979-80 and 1981-82, vanquishing the double-digit inflation of 1979-80 and bringing the unemployment rate into double digits for the first time since 1940. Volcker then declared victory over inflation and piloted the economy through its long 1980s recovery, bringing unemployment below 5.5 percent, half a point lower than in the 1978-79 boom and helping Ronald Reagan convert the American people to Reaganomics. Volcker was powerful because he was making monetary policy. Central banks are powerful everywhere for the same reason, although few are as independent of their governments as the Fed is of Congress and the White House. Central bank actions are the most important government policies affecting economic activity from quarter to quarter or year to year.
» Read more: Banks and Monetary Policy: the Mechanics of Interest Rates Setting
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