Hello from Cedar Rapids, Iowa. Welcome to the IowaMortgageGuy Blog! Glad to have you as a guest and hope to see you back again soon. Hope you find the information useful and informative.
It takes a lot of effort to keep our countries financial system balanced. Have you ever wondered how some of the policies and actions affect the market? I hope you find the below information helpful in understanding how certain things affect our markets, interest rates and our overall economy.
Inflation and deflation affects many things and they occur in what are referred to as economic cycles known as expansion, peak, a recession and a trough. This also best describes what is also known as a business cycle. Expansion is the demand for goods and services that outweighs supply resulting in price increases. In turn, that expansion causes inflation. As prices continue to rise, the result is an economic slowing and usually a recessionary period follows. A continued recession causes employers to layoff workers and which results in prices falling. This is deflation as defined by persistent decline in general price levels. Of course, inflation and deflation also affects corporate profitability and in turn affects our economy.
The Federal Monetary Policy attempts to control the credit and money supply in the economy. It's this control that affects mortgage interest rates, bringing with it a decrease or an increase in economic activity. Overall, the primary focus of monetary policy is to control inflation. The role of the Federal Reserve falls into a few general areas. The Feds are in charge of the monetary policy, supervising banks and depository institutions, protecting the rights of consumers, maintaining the stability of the financial system and providing certain financial services to the US Government, the public, domestic financial institutions and foreign official institutions.
The Federal Fiscal Policy is another method the government uses to maintain a stable economy through taxation and expenditures with the focus being on stable economic growth with high levels of employment. Inflationary economy usually means decreased expenditures or increase taxes to slow down demand and in recession you usually see increased expenditures and tax cuts to increase spending and stimulate the economy.
The Federal Reserve System in its attempts to control inflation and employment does so by raising and lowering short-term interest rates (ie Fed rate Cuts or Increases). Fed rate increases tighten up the money and credit supply and in turn slow down the economic activity and thus slows down inflation also. A decrease in interest rates makes credit and money more readily available and generates economic activity and is done to reverse a possible or actual recession. Interest rates affect the cost of money which directly affects the cost of business. Therefore, it is a great tool for the Feds to influence the economy by manipulating interest rates. Banks also borrow money from each other and the Fed Rate affects what they charge each other for short term money and the prime rates they charge their commercial borrowers for unsecured loans. Since banks must lend their money at a higher rate than they borrow it, you can see how that may affect CD rates, savings accounts, credit card rates and mortgage rates.
The other way the Feds influence the economy is by buying and selling Government securities to member banks through what is know as the Federal Open Market Committee (FOMC). They (FOMC) buys securities from member banks to give those banks credit in their reserve accounts allowing banks to make more loans which lowers rates also. The converse is true if they sell securities to the banks, then rates go up and money gets tighter and lending rates usually increase.
Economists watch closely indicators such as Gross Domestic Product (GDP) and the Consumer Price Index (CPI) in making decisions on the monetary policy. The GDP is a measure of all goods and services produced in the US and the CPI measures changes in the prices of the goods and services in the US like food, entertainment, utilities, clothing and medical services.
As you can see, there is not one thing alone that plays into moving the economy one direction or the other and sometimes, the effects and results of the strategic moves are delayed especially when most times, it is not always clear that you are in a period of recession or inflation until you come through to the other side.
Understanding what drives the market and mortgage rates can give you that leg up when discussing options with your lender.
Putting my interest in yours,
Jeff Harding
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