Federal Reserve System, Interest Rates and Money Supply (SLP) Essay

Federal Reserve System, Interest Rates and Money Supply (SLP) - Essay Example By increasing the interest rates Federal Reserve attempts to condense the supply of money by making it more expensive to obtain. There is no immediate effect on market with the increase in interest rate. However what happens immediately is that it suddenly becomes more costly for banks to borrow money from the central banks pushing the banks to increase the interest rates for lending money to their customers. (Siddhartha Jha, 2011) Expenses necessary for the survival are called committed expenses. As these expenses are mandatory, there purchasing decisions are not affected by fluctuations within the interest rate environment. Further, such expenses are met against cash so interest expenses are not applicable. Committed expenses include rent, transportation, groceries, and health insurance, telephone and electricity bills. Expenses associated with consumer goods, which depreciate quickly and rarely add value to one’s bottom line are called discretionary expenses. Expenses on designer clothes, vacation packages, high-end electronics and memberships to exclusive clubs are discretionary expenses. With the rise in interest rates discretionary spending reduces sharply because higher interest rates increase financing costs and lower disposable income. (John Bates, 2011) Spending on big ticket items expenses like purchasing a car or financing a home is encouraged with stable incomes and low interest rates. The spending decisions for big-ticket items are more so affected by the overall economy because despite a low-interest rate environment, one would be unlikely to take on a mortgage to buy a new home, if one’s job is in jeopardy. On the contrary, a strong economy and impressive stock market returns encourage raising cash to purchase a luxury car. Lower interest rates on real estate loans are better for the real estate market in general because it