The Federal Reserve Board, Essay Example

The Federal Reserve Board has kept the federal rate to a nominal rate in recent years. Explain the rationale for this behavior, indicating the effectiveness on financial markets. Predict the federal fund rate over the next five years, indicating the likely impact on financial markets. Provide support for your rationale.

The recent years have witnessed a sharp decrease in nominal rate despite the fact that it can get very high at some given time. The biggest question that many people might be currently asking is why the FRB has chosen to maintain the rates at such low levels. Below are a few explanations trying to shed light on to this phenomenon.

One of the biggest contributors to the low rates is credit risk. This dwells on the difference between the risky and the riskless debts, the ones that might be paid back and the ones that might not be paid back. Raising the interest rate puts the borrower at a point of not being capable of sufficiently paying their debts especially during the tough economic times. To enable them borrow and invest more, the Federal Reserve board has chose to keep this at nominal rate.

Another contributor to this phenomenon is inflation. In most cases when the FDR lends out to people, they expect to get the money back with some interest. Due to inflation, the interests earned may almost bring no significant meaning to them. It thus forces them to lower the rates to encourage as many people as possible to invest and take loans. The nominal rate can always be divided into real rate and expected rates. The US government issues TIPS (treasury inflation protected securities) which protects borrowers against inflation, thus offering the banks real rates of return.

Due to the ever-increasing cost of living, the next five years would witness a great decrease in the rates. This means that the federal system may lower their rates to enable borrowers pay their debts easily and comfortably.