Article Critique Unit

ARTICLE CRITIQUE

ArticleCritique

Unit

“If the Fed wants more inflation, it should say so” is the titleof an article published in The Economist authored by RyanAvent that discusses the actions of the Fed’s Open Market Committeein setting benchmark interest rates. The article takes aconfrontational approach as indicated by the title. The author isincensed by the fact that the Federal Open Market Committee headed byJanet Yellen was coy to acknowledge its desire for higher inflationrates. Making such intentions known is beneficial to the economy. Theauthor’s argument is borrowed from the inverse relationship betweeninterest rates and inflation. Given that interest rates have remainednear zero in the last several years, individuals are likely to haveborrowed more, spent more, and grown the economy. Ideally, access toloans increases the amount of money in circulation without activelyincreasing quantity/quality of goods and services leading toinflation indicated by a general increase in prices. Thus, by the Fedmaintaining low interest rates, it is implying that it is receptiveto inflation rates above the target of 2% but has not made thatclear.

Therefore, to arrest inflation the Fed should increase interestrates. However, the US is not a closed economy. An increase inbenchmark interest rates would attract capital from all over theworld where most markets have maintained near-zero rates. Investorswould flock to the US in anticipation of better returns on saferassets. The demand for the dollar would go up placing a drag ongrowth. As a result, the price of riskier assets would fall and thebenchmark interest rates would have to be lowered again to drivegrowth. Thus, the actions of the Fed are tied up with the fate ofother markets. In the current case, attempts to increase interestrates have been hindered by fears of slowing the economy. Again,maintaining interest rates at near-zero is dangerous as it denies theFed enough room for maneuver without resulting into less-proven toolssuch as negative rates. Thus, the author observes that the Fed is ina very precarious situation.

However, the author has a potential solution to the problem. Heargues that it is possible for the Fed to increase nominal interestrates without necessarily increasing inflation-adjusted or realinterest rates. Such a move is possible if expectations of futureinflation rate keep rising to a level not too low to be ignored i.e.consumers only worry about significantly high inflation rates.Assuming that there is public expectation of moderate medium-terminflation rate growth (2% -4%), then the nominal interest rates wouldregister relative increment without necessarily increasing realinterest rates. Thus, the author believes that it is wrong for theFed to be shy about its intentions of pursuing inflation rates higherthan the set target of 2%. Making such information public wouldencourage public expectations of moderate medium-term inflation rategrowth. Unfortunately, the Fed has established a culture of strictadherence to low inflation rates that it would require a considerablylong period of time for the public to change its beliefs about theFed. Thus, to address the current cycle driven by fear, the Fedshould strive to change public expectations in terms of inflationmovement.

Thus, from the above discussion, it is clear that the Fed is not outof options in setting the economy on a recovery path unhindered byfear of stagnation. Being open about the Fed’s policy and approachto the current situation would ideally solve the current dilemma ofincreasing interest rates without encountering the fears of thecontractionary nature of higher interest rates. Thus, the articleadequately covers the economic concepts of interest rates andinflation.

References

Avent, R. (24thMar 2016). If the Fed wants more inflation, it should say so. TheEconomist.

Retrieved from&lthttp://www.economist.com/blogs/freeexchange/2016/03/low-end-theory&gt

Article critique Unit

ARTICLE CRITIQUE

Articlecritique

Unit

The article titled “What negative interest rates mean for savers &ampinvestors” by Sara Zervos discusses the impact of negativeinterest rates on savers, investors and the larger economy. Whilenegative interests are yet to be announced in the US, they are commonin European countries and even in the European Union. In the article,the author presents a deeper understanding on why interest rates,understood as the cost of money, can be negative. A negative cost ofmoney would mean that depositors have to pay banks for holding theirmoney while borrowers are rewarded. Ideally, negative interest ratesare intended at driving economic growth though there is no clearevidence to indicate such.

Central banks enact negative interest rates to discourage banks fromholding large deposits but instead invest such monies. Investmentscreate employment and drive growth through the multiplier effect. Lowinterest rates are thus intended to encourage investments and expandeconomic growth while negative interest rates also target the samegoal. The US has maintained near-zero interest rates for severalyears but has never hit sub-zero levels. The sub-zero levels are newand emerged after the 2008/09 global financial crisis that sawvarious central banks around the world enact expansionary monetaryand fiscal policies to jumpstart economies. Two of the common avenuesemployed were lowering of interest rates and increasing governmentspending through stimulus programs.

Under certain conditions, negative interest rates are justifiable.The author cites two common conditions under which negative interestsmay apply: in deflationary economic environments and amongrisk-averse investors. Such conditions are what have necessitatednegative yields in the bond market in countries such as France,Austria, Finland and Sweden as per February 2016 data. Taking cuefrom these countries, Zervos believes that even the US may need toexplore the option of negative interest rates. She argues that theAmerican economy has been stagnating on near-zero interest rates andthus negative interest rates in the banking sector might need to beconsidered in the near future.

The US bond market has already experienced negative interest rates.This has been in the face of low interest rates that have existed inthe last several years. Ordinarily, interest rates and bonds have aninverse relationship. This means that if one goes, the other goesdown. The article indicates that this kind of relationship is createdby the lower risk associated with bonds. Where interest rates arehigher in the market, investors are likely to invest money elsewherethereby decreasing the demand for bonds and hence lowering of thebond interest. Thus, by ensuring that bond interest rates arenegative, investors are likely to explore other investment options.In this case, the negative bond rates recorded in 2015 in the USspurred investment in other sectors thereby growing the economy.

However, the American economic situation as of February did notwarrant sub-zero interest rates. The author believes that lowinterest that hit rock bottom zero in 2015 did enough to stabilizethe economy as indicated by stabilized inflation and employmentfigures. Accordingly, there was no need for lowering the interestrates to sub-zero levels. Given that such rates are expansionary innature, they are not necessary in a stabilized economy. Whileeconomic theory would suggest the validity of such extreme measures,there is no guarantee of their impact on the economy. Thus, negativeinterest rates are likely to benefit investors while they are likelyto hurt savers. Theoretically, low interest rates also benefit thelarger public through cheaper access to loans that power consumptionand drive aggregate demand. Thus, the article articulates well howthe concept of money and banking applies in real life.

Reference

Zervos, S. (22ndFeb 2016). What negative interest rates mean for savers &ampinvestors. Forbes

Magazine. Retrieved from&lthttp://www.forbes.com/sites/sarazervos/2016/02/22/negative-interest-rates-coming-soon-to-a-bank-near-you/#6b7c89cb3318&gt