Tuesday, March 13, 2007

What's real role of Federal Reserve Board?

One big factor that affects the bond market is of course interest rates. No matter how high the credit ratings of a bond issuer, even if it's the United States government, its bonds' market value will go up if interest rates fall and down and if they rise. So depending upon the whim of the Chairman of the Federal Reserve is not one of the advantages of fixed income investing.


What did the economy do before the Federal Reserve was created to manipulate interest rates to affect the economy. Gosh, they went up and down based on the market demand for borrowing money. During booms periods, there must have a large demand for money, which automatically drove interest rates up. When interest rates got too high, then the demand had to drop . . . slowing down the ability of businesses to expand and be created, thus slowing down the boom.

Once the boom slowed down, demand for money slowed down, and so banks would have had to lower interest rates to make loans, and thus help stimulate the economy to get it out of the bust period.

In short, the interplay of supply and demand for money would have worked automatically to help curb the excesses of the business and economic cycles. Variations in demand for money should have done what we now depend on the Federal Reserve to do for us -- slow the economy down during a major boom and stimulate it during a major bust.

What do we need the Federal Reserve for anyway? Why not just let banks set interest rates based on market demand for money?