It was shown in the monthly job reports that a further 5000 U.S. jobs were lost during October and the unemployment rate is rising. Challenger Gray & Christmas reported that job cut announcements were their highest this month since January of last year, and it is the job of the Fed to come up with a solution to this problem to ensure that the economy does not continue to fall in this direction. The Federal bank will have to act using their monetary policy to deliberately change the interest rates in order to affect the economy.
Since interest rates affect spending on durable goods, investment spending and saving, changes that are made to interest rates will have a direct affect on the aggregate demand. The effect of a cut in interest rates will cause consumers to spend more of their income. Rather than investing their money in a bank account and accumulating interest, the consumers will want to borrow money with lower cost, and spend the money that they do have. This will cause an increase in the demand of goods and loans and a shift of the demand curve to the right (graph 1). Less money will be kept in banks and more money will be circulated in the consumption of goods, and borrowing through loans. Lower interest rates have a positive impact on share prices and will help the economy to regain some of its stability.
The half-percentage cut may be a more aggressive action to take, but one economist, Diane Swonk believes that if the cut is going to be made it should be done so in one action, not drawn out with various quarter-percent cuts. Others believe that by leaving the possibility to make another quarter-percent cut later on, the consumers will feel more secure that the Fed is able to make further cuts if the economy remains weak. Either way, the cuts are necessary for improving the economy and avoiding a recession. Even if they will not take full effect initially, the public will be provided with a feeling of security and this alone can help in stabilizing the economy.
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Bibliography: “How far will the Fed go?”, Justin Lahart, CNN/Money staff writer, cnnmoney web page, http:/money.cnn.com/2002/10/31/markets/halfpoint/index.htm