“WTF EssaySnark. What does this have to do with getting into business school?!?”
Coming on the tail of our you should pay attention to the news series last week, we thought we’d quickly talk today about interest rates, and why they matter, and what’s going on the world that would cause them to change.
Some of you may be rolling your eyes, that this is so, so basic. Maybe you studied econ in undergrad, or you work in finance today. For you, this may seem rudimentary.
But there are lots and lots of BSers these days who are coming into the MBA from very different fields, including the military, and education, and the arts. If you studied English or history in college, you might not have a clue about interest rates — and you might not have even ever thought you would care. (You might still be right on that last count.) But you’ll need to learn about interest rates and how markets move when you’re studying for your MBA, and getting a grasp on monetary policy and what the U.S. Fed is doing today can also help you plan for your future.
And it can let you plan for today.
If the market is crashing, do you buy stocks? Or sell them?
Most people sell. That’s why it’s crashing. When more and more people want to sell, and fewer and fewer people are buying, then the price needs to keep going lower before those who will buy are willing to pay for it.
Some people may think the market is not going to go much lower, so they take the opportunity to buy the dip.
Other people are more bearish and they think that the market is so long overdue for such an immense correction that they’re sitting on their money and waiting for it to go down further.
Please remember though: The stock market is not the economy. Usually these things go in lock-step, or at least on a lag: As the economy improves, the stock market responds.
Today’s price of a stock is indicative of what people think that company will do in the future. If the consensus view is that a company will make money, the price will be high and stay high. If analysts think overall that prospects are poor, its price should reflect that, and will go down. It’s about future expectations.
Whenever the U.S. Fed changes interest rates, it’s done to either stimulate demand — make people buy stuff — or put a damper on buying.
Why would you ever want to put a damper on buying?
Inflation is the main reason. Inflation hasn’t been a real threat to the economy in a very long time, but at some point, it will become one again. One of the main worries for the folks at the Fed traditionally has been keeping inflation in check.
Inflation just means that prices in goods and services are rising. A dollar today buys less than what a dollar could buy yesterday.
If too many people are buying a product, then the price goes up, and if that happens too much, then it’ll become less affordable, and fewer people will buy. If too many companies are buying a commodity, the same thing happens — but in the case of commodities that companies require for production, then the company needs to keep buying even at the higher cost, and eventually, that higher cost has to get reflected in the price that consumers pay at the end of the chain.
The Fed tries to keep inflation down because too much inflation slows the growth of the economy. If inflation starts to spike, the Fed considers raising interest rates to cool it. When the banks are charging more interest to make a loan for a house or a new car, then that means fewer consumers will want to get that loan. Higher rates means fewer people will go for the big-ticket items. (We’re oversimplifying here by vast amounts.)
When the economy gets into trouble, like in 2007 and 2008 when the real estate market in the U.S. fell apart, then the Fed can respond by lowering interest rates. This will prompt some people to get back in the housing market (for example) as buyers, because it’ll be cheaper to buy and the investment they’re making in real estate (for example) will earn them more money. Their buying dollar goes further.
With that basic framework in place:
What did the Fed do today in the U.S. with interest rates, and why?
Would love to hear thoughts from smart folks out there who know about this stuff! Comments are open if you have something to teach us.
PS: Even if you think you don’t care about this stuff… You need to care! Not just because you’re going to study it in business school, but because knowing about how these things work will let you make better decisions for yourself and your family and your life, in finance and politics and everything in the external world.