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UpsideVII t1_j21g6nj wrote

Reply to comment by ejMileman in Ask Anything Wednesday - Economics, Political Science, Linguistics, Anthropology by AutoModerator

The market does set the (long-run) price for money.

The price of money is the real interest rate which is the nominal interest rate (managed by the fed) minus inflation (determined by the market). If the fed tried to perpetually lower the nominal rate, this will lead to higher inflation (assuming nothing else is changing) as the market restores the "natural" real interest rate.

The reason we do this is because highly variable inflation in very costly. For example, it makes it risky to lend money (as you don't know if the money will be worth much less when you get paid back due to a large bout of inflation) which makes it costly for businesses to raise capital and depresses the economy.

By manipulating the nominal rate so that it "absorbs" all the market fluctuations in demand for money (which cause variation in the real rate), the fed is able to maintain a low, stable inflation level and eliminate this problem. This is why you will sometimes hear about the fed's "inflation target" and why we find it optimal to have an entity managing the money supply.

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Thewhiterabbit7 t1_j22auol wrote

How is inflation determined by the market? You're not implying that inflation is caused by the market correct?

I also don't believe that fed does an efficient job at "absorbing" inflation as seen currently with record high inflation. They respond way too slow. There is also something to be said about the Fed manipulating the nominal rate so much that is causes price distortions in the economy as seen in 01' and 08'. Many have argued that the record low nominal rates have caused bigger booms and bigger busts as it causes speculation in the markets. Why would you put money in a "savings" account when you can only make .1%? Does lower interest rates in your opinion not spur speculation and greed since you cannot find a good return in any savings account with low nominal rates?

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