U.S. Historical Interest Rates and the Money Supply.

In Money Supply on May 3, 2011 by CQCA

Interest rates are often used as a tool to counter inflation. An increase in interest rates will cause the value of currency to increase because holding the currency (in a bank account) will now yield a higher return. Conversely, lower interest rates will decrease the yield on holding currency, and therefore decrease the value of currency.

However, as is shown in the chart above, interest rates do not have an impact on the money supply. When the Federal Funds rate was increasing between the 1960s and the 1980s (blue line), the money supply (green and red lines) was also increasing. When the Federal Funds rate began to fall after the 1980s, the money supply continued to expand. This indicates that there is no real correlation between the money supply and interest rates.

The Federal Reserve is focused on and directs commentary towards interest rates, but the real source of inflation comes from the money supply. According to the New York Federal Reserve, “[M]oney supply growth does not provide a useful benchmark for the conduct of monetary policy.” The New York Fed will be to the financial system what the Hindenberg was to airship travel.

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