Economics, Business Cycles and Bank Rates

There is a distinct and recurring cycle of general economic conditions applying force on the demand and supply of credit and in time pressuring the overall direction of interest rates. The entire economy will expand and contract or move in cycles as interest rates move up and down. Both, the forces exerted by changing levels of interest rates and the growth and contraction in the economy, push and pull as the growth of our economy trues to reach a level of equilibrium.

The Federal Reserve has stressed the importance of the role they play in maintaining consumer and investor confidence in their ability to manage inflation and control interest rates. Based on this knowledge and the force of the underlying current the feds has on the direction of interest rates, it is probably fair to say that the fed will apply pressure to raise rates if there is strong hint of inflation and conversely, reduce or leave the forces on interest rates applied by the fed stable if inflation remains moderate.

The business cycle or economic cycle are terms used to refer to the up and down movements in economic activity measured by various economic indicators and variables. The business cycles are a form of economic fluctuations in the overall economy signifcantly influenced by the general level of interest rate. During economic expansions, the economy, measured by indicators like jobs, production, and sales, is growing–in real terms, after excluding the effects of inflation. Recessions represent the opposite movement in activity measured by periods when the economy is shrinking or contracting.

The business cycle involves shifts over time between periods of relatively rapid growth of output and periods of relative stagnation, ecomonic decline or recession. These fluctuations are often measured using the real gross domestic product. Despite being named cycles, these fluctuations in economic growth and decline do not follow a purely mechanical or predictable periodic pattern.

many economists simply believe that business cycles are more of a monetary phenomenon and interest rates are the biggest forces used to stimulate increased borrowing or conversely contract economic growth. This position places the direction of the economy squarely on the shoulder of the Federal Reserve and its influence on short term rates and the money supply.

To maintain the Federal Reserve’s policy of stabilizing output in the short run and promoting price stability in the long run, the government lowers the supply of reserves in the banking system, and the funds rate rises. A higher level of interest rates will most often lead to less borrowing and spending. This in turn alleviates the pressure the market for wages, materials and physical resources. Since selection and control of the Fed funds rate is the key monetary policy instrument of the Federal Reserve, it is important to understand what influences the fed in setting the direction of the target fed funds rate.

In the course of determining the direction of monetary policy, the Federal Reserve monitors the economy and follows a large set of indicators on present and future output, employment, inflation, and economic conditions. By monitoring this subset of economic indicators the fed evaluates the overall economic condition of the economy and measures the business cycles. Monitoring economic activity and controlling the direction of rates is a very difficult balancing act for the fed to perform. For the most part Federal Reserve officials do not believe that there is a single indicator is reliable enough to be used as the guide to policy.

Movements in several key indicators help the Federal Reserve monitor how successful it is in attaining its two primary economic goals, which are to promote maximum output and employment and maintain stable prices. During turbulent times, the objective of maximum output and no inflation can be a vast and difficult goal to uphold. Measuring business cycles is a difficult and compelling task. Calculating and monitoring the changes in the business cycles and the economy that may lead to interference in the Fed’s goal is in itself a difficult goal. Even agreeing on the present state of any business cycles can be the grounds of many economists’ debates.

Charting the Business Cycle

The National Bureau of Economic Research or NBER measures and determines the peaks and troughs in the U.S. economy. Their findings are the generally accepted delineations of recessions and expansions in the business cycle.

The NBER is a private, nonprofit, nonpartisan research organization founded in 1920. The NBER is committed to understanding how the economy works and examines the business cycle and long term economic growth. The Bureau provides research and disseminates the data and findings among academics, policy makers and business professionals. Monitoring the chronology of business cycles is one of its longest standing functions.

Within the NBER, the Business Cycle Dating Committee plays the key role in determining business cycle dates. The committee is comprised of a small group of leading business cycle experts. This group reviews a variety of economic statistics and indicators of U.S. economic conditions before deciding on the turning points in the economy, business cycle peaks and troughs, which define periods of recessions and expansions.

The NBER web site describes a recession and the types of economy wide economic data used to identify a recession in the U.S. economy as follows:

A recession is a significant decline in activity spread across the economy, lasting more than a few months, visible in industrial production, employment, real income, and wholesale-retail trade. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough. Between trough and peak, the economy is in an expansion. Expansion is the normal state of the economy; most recessions are brief and they have been rare in recent decades.

Because a recession or hyper growth in business cycles can influence the economy broadly and is often not confined to any one sector, the Fed analyzes economy wide measures of economic activity carefully. The Fed measures a variety of indicators to try and gauge economic activity and trends in domestic job growth, output and inflation.

This entry was posted on Sunday, October 12th, 2008 at 12:14 pm and is filed under Banking and CD Guide. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.