Definition: The term used to describe how the Federal Reserve Bank has the power to slow down the economy if it is growing too fast, but not the power to speed it up if it is growing too slowly.Example: On January 22, 2008, the Federal Reserve Bank cut a key interest rate from 4.5% to 3.75% as it realized the economy was stalling. It continued to do so, finally cutting the rate to 0% on December 17, 2008. Still, the economy continued to lose altitude. The Federal Reserve seemed powerless to stop the economic slowdown.
Investeach explains: Let’s say you have your dog Fido on a long leash. You look away for a moment and in that instance Fido walks to the neighbor’s garden and starts trashing it! You pull on the leash and reel him, hoping nobody saw what just happened. A few moments later your long lost friend shows up and greets you with a hug. Fido jumps all over her with his dirty paws. He just won’t leave her alone. You can’t make Fido go away by pushing on the leash. The leash, or string, only works one way!
What do interest rates have to do with economy? Well, if interest rates were lifted higher because the economy was growing so fast that the prices of everything were skyrocketing, less people could afford to borrow money to renovate their homes, buy a new car, or grow a business. Less carpenters and auto plant employees would be put to work, the economy would slow down and prices would come down.
If the Federal reserve lowered interest rates because the economy was growing too slowly or even shrinking, it would be easier for people to afford borrowing and spending money. The problem, as we’ve discussed above, is that even if rates are lowered to zero, the Federal Reserve can’t make people and businesses borrow and spend. They may have simply decided to save more and/or pay off existing loans.
Riddle me this:
1. What does the Federal Reserve Bank adjust in its attempt to keep the economy growing at a reasonable pace?
2. Why is it that the Federal Reserve Bank can slow the economy down but can’t force it to speed up?
3. Connect your answer in 2. above to the expression “you can’t push on a string”.