The Federal Reserve Bank in the United States of America is solely responsible for the alteration of the interest rates in the country. The market conditions such as the increasing levels of inflation in the US and the rest of the world has a bearing on the interest rates in the country (Bushman et al., 2018). In the recent past, banks and other financial institutions in the US have had to prepare for a rise in the interest rate risks with the threat of skyrocketing or nosediving all of a sudden which may lead to losses within the institutions. One of the most significant causes of the interest rate risks is credit risks. The credit risk is determined by the debt to equity ratio, and as the interest rates rise, the equity of the banks falls as they pay more interest rates (Bushman et al., 2018). In preparation for the interest rate risks, the bank managers are expected to begin by avoiding the ignorance of the interest rate risk. One of the ways to prepare for the management of the interest rate risks is hedging. The bank leaders are advised to hedge the interest rates to maintain them at a constant rate even in adverse market conditions (Bushman et al., 2018). Hedging may be expensive but remains to be the most effective way of managing the interest rate risks in the US.
Changes of the interest rate by the Federal Reserve Bank works towards the increase or decrease of the rates that the financial institutions set for their market. The changes in the interest rates set by the financial institutions are subject to the forces of supply and demand, which determine the rates of interest charges (Williamson, 2019). The Federal Reserve Bank makes use of supply and demand in that when the supply of credit is increased, there is a significant rise in the amount of money that is made available to the borrowers. The increase of deposits from the American consumers raises the interest rates in the financial institutions since they treat the same as a lending activity to the banks. On the other side of the spectrum, an increase in the amount of money that the banks are supposed to lend increases the amount of credit available to the economy, which lowers the interest rates (Williamson, 2019). The Federal Reserve Bank thus makes use of the technique of optimizing the amount of money available to the economy as the credit to achieve its overall ability to manage the interest rates for the financial institutions in the US. In that way, the changes in the rates of interest increases or decreases the rate of interest charged by the financial institutions.
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The policies of the Federal Reserve Bank directly impact the rates of interest set by the institutions for their customers. The Federal Reserve Bank has three instruments of monetary policy, which include the open market operations, reserve requirements and the discount rate (Armenter & Lester, 2017). The Federal Reserve Bank makes use of the market operations as the primary tool to influence the supply of money to the reserves of the various banks. When the Federal Reserve Bank wants to increase its reserves, it purchases securities and makes payments for them by depositing the funds to the account that it maintains in the primary bank of the dealer. The constant purchase and sale of securities by the Federal Reserve Bank lead to the changes in the amount of lending available to the financial institutions, which affects the interest rates (Armenter & Lester, 2017). The goals of the various monetary policies that the Federal Reserve Bank implements to control the interest rate charges in the US are the promotion of maximum employment, the stability of the prices and the moderation of long-term interest rates.
References
Armenter, R., & Lester, B. (2017). Excess Reserves and Monetary Policy Implementation. Review of Economic Dynamics , 23 , 212-235.
Bushman, R. M., Davidson, R. H., Dey, A., & Smith, A. (2018). Bank CEO Materialism: Risk Controls, Culture and Tail Risk. Journal of Accounting and Economics , 65 (1), 191-220.
Williamson, S. D. (2019). Interest on Reserves, Interbank Lending, and Monetary Policy. Journal of Monetary Economics , 101 , 14-30.
