Question

Some individuals suggest that an increase in wages can be associated with an increase in interest rates. Apparently, this idea shows the tendency that the financial institutions would be committed to take part in the efforts to increase wages. Others argue that there is no any historical evidence that the financial institutions would be worried about wage increase. They also raise some important questions such as: How on earth would an interest rate to a proportion of above 4% would be allowed to exit in the first place? Who is the major influential entity to propagate the belief that any interest rate below 4% would be considered historically low, as if banks are created to amass income more than anybody? Where would the logic rest? The Fed is now determining interest rates in a fashion that facilitate conditions for the economy to take its proper course. So, upon proper recovery, would it mean the financial institutions could have the legitimacy to adjust the rate according to the public interest? Please consider consumer confidence index in influencing interest rate. How would you address these questions, which have been forwarded to all members of the course.

Answer 1

The main determining entity of interest rates in the economy is the Central Bank of the country. The Central Bank sets the interest rate by controlling the amount of money supplied in the economy. In times of recession, the money supplied is increased to reduce interest rates in the economy to increase the level of investment in the economy. During the times of boom, the interest rates are increased to recycle aggregate demand and thus inflation rate in the economy. Giving autonomy to the financial institutions in adjusting interest rates is not a viable option as they might not take the decision in the interest of the economy. Thus, the decision to control money supply which ultimately influences interest rates should rest with the Central Bank of the country.