macroeconomics

The Concerns of Economies and the Federal Reserve with respect to Interest Rate Hikes and Inflation The Federal Reserve is the main monetary institution in the United States . As such it has the enormous task of ensuring that the money supply in the economy is at a steady rate and it does this by implementing certain fiscal policies and controlling interest rates This discourse therefore will seek to discuss the effects of interest rate hikes and inflation on the economy and how these factors affect the economy and the policy formulation and

implementation of the Federal Reserve

Effect of Interest Rates on the Economy

Interest rates affect the economy by determining the rate of investments . Any increase in the interest rates causes a decrease in the level of investments due to the fact that it means that a higher amount has to be paid for every unit of currency borrowed . This is not a negative effect however because rising interest rates usually mean that the economy is growing and that there is a need to increase interest rates to control or decrease the money supply available to counter inflation (Baumol , 2006

The effect of the interest rate in the economy and on money supply can be explained in simple supply and demand terms . When the economy is growing , there is a need for more capital to fund investments and capital expansion . This increase in demand also causes a corresponding increase in the rates because people are now willing to borrow money at higher interest rates as opposed to when the economy is in a slump (Baumol , 2006 . The concern of the Federal Reserve in this matter which will be discussed in the later section , is that this could lead to an oversupply of money causing sharp inflation within the economy

Effect of Inflation on the Economy

Inflation is said to occur when there is an oversupply of money causing the prices of goods to react accordingly in relation to the amount of increase and the relative wage rate of individuals (Baumol , 2006 There are two (2 ) main schools of thought regarding the causes of inflation and these are the quality theories of inflation and quantity theories of inflation . The quality theories generally assert that as a result of pressures in the economy the prices of commodities increase The quantity theory on the other hand postulates that inflation is determined by equations with regard to money supply its velocity and exchanges

The other theory on the cause of inflation is based on the law of supply and demand in that the more disposable income people have as caused by higher wages , the greater the demand for items thus allowing suppliers to raise prices for the items that they are selling (Baumol 2006 . This is consistent with the theory of Abraham Maslow on the hierarchy of needs which states that as wage increases , the disposable income for the other items increases since the level of need for basic necessities remains at a...