Six Facts: What We Need To Know About Lower Interest Rates

The Federal Reserve just reduced its target interest rate by .5% (aka 50 basis points). As a result, the federal funds rate is now between 4.75% and 5%. Expressed by Fed Chair Jerome Powell, the goal is to maintain their high employment and stable prices mandate.

Six Facts: Lower Interest Rates

1. The Fed’s lower rate is a target.

When the Federal Reserve wants rates to sink, it pays banks a lower “over night” rate of interest for the extra funds–the reserves–that banks keep with them. That lower rate diminishes the incentive for banks to increase their reserves with the Fed. As a rate that banks receive, it becomes a floor that banks charge other banks (the fed funds rate). Consequently, we have a process bringing rates down. They do not decline because of a directive from the Federal Reserve.

2. The Fed’s lower rates increase banks’ loanable funds.

To illustrate banks keeping more of their reservable funds rather than the Fed, we shift our supply curve. Correspondingly, on our Y-axis, interest rates sink, and x-axis quantity goes up. Banks have more to loan to you and me:

3. Some borrowers could quickly see lower rates.

Anticipating a rate change, some mortgage rates started to drop even before the Fed made its announcement. As a result, there could be a delay before further declines kick in.

Somewhat similarly, car loan rates should soon drop.

4. But it takes longer for others.

By contrast, credit card interest rates tend to remain high with companies reducing them less frequently.

5. Depositors also see lower rates.

Because the banks are paid less for their money, they offer less to all that receive interest from them. Economists expect those rates to echo the Fed quickly.

6. The U.S. Federal Reserve was not alone in cutting rates.

Raising their rates, Russia, Brazil, Japan, and Nigeria were the anomalies. Typically though, the changes were a 25 to 50 basis point drop:

Our Bottom Line: The Price of Money

An interest rate is the price of money. Just like sweaters and loaves of bread have prices, so too does money. As a result, like all supply and demand graphs, the price of money–its interest rate–is the y-axis. Meanwhile, the x-axis is its quantity:

My sources and more:  Marketplace, here and here, had good explanatory links. But the NY Times had the best international comparison while The Washington Post focused on the domestic impact of the rate cut.

Our featured image is the Federal Reserve.