A Quote by Milton Friedman
The central banks cannot control interest rates. That's a mistake. They can control a particular rate, such as the Federal Funds rate, if they want to, but they can't control interest rates.
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What central banks can control is a base and one way they can control the base is via manipulating a particular interest rate, such as a Federal Funds rate, the overnight rate at which banks lend to one another. But they use that control to control what happens to the quantity of money. There is no disagreement.
A higher IOER rate encourages banks to raise the interest rates they charge, putting upward pressure on market interest rates regardless of the level of reserves in the banking sector. While adjusting the IOER rate is an effective way to move market interest rates when reserves are plentiful, federal funds have generally traded below this rate.
Paying interest on reserve balances enables the Fed to break the strong link between the quantity of reserves and the level of the federal funds rate and, in turn, allows the Federal Reserve to control short-term interest rates when reserves are plentiful.
The insurance companies do not refer to the key policy rate when they send their statements. We can only control that rate. Long-term interest rates are determined largely by global financial markets.
The real challenge was to model all the interest rates simultaneously, so you could value something that depended not only on the three-month interest rate, but on other interest rates as well.
There's only one thing that all of the central banks control and that is the base, their own liability, and they can control that in various ways. They can control it directly by open market operations, buying and selling government securities or other assets, for example, buying and selling gold, or they can control it indirectly by altering the rate at which banks lend to one another.
I will say this: the central banks can actually support growth beyond a point. When there is no inflation, they can cut interest rates, and that is the way they support growth, but if you cut interest rate to the bone, there is nothing more to cut. It is very hard to support growth beyond that.
The FOMC has considerable control over short-term interest rates. We have much less influence over long-term rates, which are set in the marketplace.
When interest rates are high you want the average direction in which interest rates are moving to be downward; when interest rates are low you want the average direction to be upward.
It does not stand to give banks millions of dollars at an interest rate of one percent, when banks charge students an interest rate of 6 percent. Why should the banks be scalping students?
When they so-called 'target the interest rate', what they're doing is controlling the money supply via the interest rate. The interest rate is only an intermediary instrument.
The lesson for Asia is; if you have a central bank, have a floating exchange rate; if you want to have a fixed exchange rate, abolish your central bank and adopt a currency board instead. Either extreme; a fixed exchange rate through a currency board, but no central bank, or a central bank plus truly floating exchange rates; either of those is a tenable arrangement. But a pegged exchange rate with a central bank is a recipe for trouble.
Monetary policy transmission encompasses the whole continuum of interest rates; of course, the central bank only determines the overnight policy rate.
What we have to be careful is that if we drop interest rates where the rate of interest is lower than inflation, then savers will not put money in financial savings and move it to gold and real estate, which is bad for India.
The Fed's ability to raise and lower short-term interest rates is its primary control over the economy.
Of course, looking tough on inflation is part of any central banker's job description: if investors believe that inflation is going to get out of control, you end up with higher interest rates and capital flight, and a vicious circle quickly ensues.
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