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MONETARY QUESTION

Posted on: 04th Apr, 2007 05:44 pm
When the Fed raises the interest rate, where does the purchasing power of the extra money that is extracted from variable rate loans go?
Keagle, truly speaking never thought about it myself, that is a very interesting question and would like to know myself also..
Posted on: 04th Apr, 2007 06:01 pm
Welcome Keagle,

I think with the extra money, the government will be able to pay off its debts.
Posted on: 04th Apr, 2007 09:05 pm
Hi Keagledesign,

Lenders intend to protect their money and ensure that the amount returned in the form of payments is not chipped away by inflation. In order to compensate lenders for the loss in purchasing power when money is returned, the Fed has to raise short term interest rates.

Thanks,

Sara
Posted on: 04th Apr, 2007 09:23 pm
When the Fed raises the rates, the stated motive is never to raise revenue. The stated and implied motive is always to discourage borrowing or to control the economy such as preventing inflation.

If a rate increase poured revenue into the general fund just like a tax increase, there would obviously be a self-serving motive for the Fed to raise rates. And it would be an ulterior motive, completely discrediting the stated motive of controlling the economy. This is especially true in the case of raising interest rates to prevent inflation, since there is no way of knowing whether inflation would have occurred if the rates were not raised.

Furthermore, if a rate increase funded the government like a tax increase, you would think that it would be widely recognized as such, since tax increases are so sensitive and always bring forth widespread protest and criticism. Yet all rate increases are just accepted without question as being necessary punishment. A rate increase certainly affects the economy by slowing it just like a tax increase.
Posted on: 05th Apr, 2007 07:26 am
When the fed increases interest rates via "reserve requirements" or targeting short term funds including overnite rates, the extra charges are actually passed on to the borrowers {banks} as they go out and borrow "short term money" on the open market. There cost go up on the short term and they recover it by raising rates.
Posted on: 05th Apr, 2007 07:48 pm
Hi Gary

what's this overnite rate?
Posted on: 05th Apr, 2007 11:09 pm
Welcome Gilbert.

First of all, let me correct you, it is overnight rate actually. Overnight rate is the interest rate at which a depository institution lends its available funds to a similar institution overnight.

In the US, the overnight rate is the Federal Funds rate - the interest rate at which depository institutions lend federal funds to other such institutions. The federal funds are balances available with the Federal Reserve (central banking system of the US).

The overnight rate is a good indicator of interest rates on short term loans.

Thanks.
Posted on: 06th Apr, 2007 04:12 am
I have posed this question to others, including my mortgage company. They told me the extra interest of a rate increase does not go to the lender, unless the lender has its own money supply from investments, etc. Beyond that, they were not sure of the answer. Generally, I conclude that when the Fed raises the rate, it is on the money that they lend to the mortgage lenders and banks. So the customer has to pay the increase to the lender, and the lender has to pay the increase to the Fed.

My question is this: What does the Fed do with the extra money?

When the Fed raises the rate of my A.R.M., real money with real purchasing power is taken out of my pocket. Where does that purchasing power ultimately end up going?
Posted on: 07th Apr, 2007 07:49 am
Hi Keagle,

Welcome back.

The Fed invests the extra money into security bonds.

Thanks,
Jerry.
Posted on: 08th Apr, 2007 11:25 pm
Hi Keagle,

It's really a very interesting question.

But at first before answering you the question, I just want to ask why you are not log-in while asking the second question. If I am not wrong the I think you (keagle) and keagledesign are the same person. So, while participating in this forum, login and participate. It helps you to earn more mentor dollars. And you can en-cash the money later on.

Now, come to your question.
The Fed or The Federal Reserve is the quasi-governmental central banking system of the USA. The main roles of the Fed are:
  • Conducting the nation's monetary policy.
  • Maintaining the stability of the economy.
  • Providing financial services to depository institutions, the U.S. Government, and foreign official institution.
  • Supervising and regulating banking institutions.
So, to maintain the stability of economy they will increase the interest rate of the short term and long term loan. As a result, they will earn the increase interest rate amount. That helps them to provide financial services to US Government and other institutions. This way they earn more profit and helping other business sector to grow.

Thanks
Posted on: 09th Apr, 2007 02:56 am
Thank you all for your replies so far. You are correct "helping user", that I am keagle or keagledesign. I also posted message #5 as "guest". I have some questions about the registration, login, and username that I have presented to the moderator for clarification.

What I am trying to do is follow the money to its ultimate destination. Who ends up owning it and what do they spend it on? When the Fed raises the rate by ¼%, the stated reason is to prevent inflation in order to keep the economy healthy. And the increase would certainly have that effect if inflation were destined to occur.

However, when they raise that rate ¼%, also a large amount of money (I would suppose billions of dollars) is extracted from adjustable rate mortgage holders. If the money goes to the administration of the Fed, this is far more than what would be required to cover the cost of their operation. And if the money does fund their operation, it would seem like a huge conflict of interest affecting their objectivity in controlling the economy. Under those terms, a rate increase would amount to the same thing as a tax increase.

Jerry, if the money is invested in security bonds as you say, who gets the return from those investments?
Posted on: 09th Apr, 2007 07:26 am
Hi Keagle,

What I actually meant was that the government sells off the security bonds to common people and then invests the money obtained into various business sectors which needs improvement.

In order to maintain circulation of money in the market, the government issues security bonds that are purchased by common people. The people invest their money into the bonds and thus get yields or returns on their investment after a certain period of maturity.

Thanks,
Jerry
Posted on: 09th Apr, 2007 10:50 pm
Yes Jerry, that's what the Federal government does. It issues various types of bonds which are purchased by people. This is a way by which the government extracts money from the people.

The government provides for a return on the investment of its people at a certain rate of interest. The extra money that the government returns to bond holders can be obtained by raising interest rates on various types of loans.

When the government is going through shortage of funds, it raises interest rates so that not many people will be able to take out loans. Those who still go for loans will have to pay high rate of interest. This is how the government takes more money from the people. This extra money can be utilized in paying returns on the security bonds on which people have invested their money.

Regards,
Jessica
Posted on: 09th Apr, 2007 11:28 pm
Hi Keagle,

Helping_user is right. You can just login to your account and participate in our discussions. But I think you have some queries regarding registration and login. I haven't recieved such queries from your end. So, just put them down here so that I can explain them to you.

Samantha
Posted on: 10th Apr, 2007 12:09 am
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