ECO 306 Notes for Class
The Fed Funds Rate is the most important interest rate in the world since it influences other
interest rates as well as the value of the US currency. The interest rate that banks will pay when
borrowing money overnight on the federal funds market is known as the federal funds rate. The
rate affects credit card interest rates as well (Amadeo, 2021). To support employment and control
inflation, the Federal Open Market Committee (FOMC) modifies the Federal Funds Rate
benchmark. The FOMC's activities are a means of fostering a robust economy (Amadeo, 2021).
Since I was a high school student when these events occurred, I decided to focus my analysis on
the years 2000 through 2010. Starting in 2000, while the Dot Com explosion was still in
recovery, a lot transpired throughout this decade. The terrorist attacks on the United States in
2001 caused an even worse economic crisis, and uncertainty caused it to become even more
unstable. Another economic shock brought on by the housing crisis in 2007 would require years
to recover from.
The US economy entered a recession following the 9/11 terrorist attacks. In order to maintain the
economic growth that was taking place by 2003, the FOMC started to increase the target interest
rate from 1% to 5.25%. (Labonte, 2008). Housing prices began to soar in June 2004; by June
2006, the housing bubble was poised to explode. Due to the market crash and over ten million
people losing their homes due to the federal funds rate rising so quickly and so many people
having adjustable-rate mortgages (Andres, 2018).
Following the attacks, the stock market was shut down for a week, the DOW fell by 700 points,
and the third quarter of 2001 saw a 1.7% decline in GDP. To aid in the recovery of the economy,
the FOMC cut interest rates by 0.5% to 3.0%. The FOMC attempted to stimulate the economy by
decreasing interest rates, but by June 2003, unemployment had risen to 6.3%. (Amadeo, 2021).
Federal funds rates were thought to be remarkably low.
While the FOMC tried to calm down the hot market by raising interest rates, house prices were
soaring at the same time. The housing bubble burst as a result of rising interest rates and the
prevalence of subprime mortgages, and mortgage interest rates dropped to record lows (Amadeo,
2020). Although they reached a new low in 2020 as a result of COVID-19, mortgage interest
rates at the time were regarded as historically low (Miller, 2021).
The fed funds rate graph demonstrates how the rates were impacted by the decade's events. After
the 9/11 terrorist attacks, the interest rate had its first big decline in 2001. In 2009, when the
housing bubble broke and the Financial Crisis struck, there was a second sizable decline. The
federal funds rate was decreased to around 0%.
The graph of 30-year mortgage interest rates demonstrates how the decade's events affected the
rates. Mortgage interest rates decreased because of the terrorist attacks on September 11, 2001,
which stressed the economy. After 2001, there was some fluctuation in the rates, but in 2009, the
housing bubble and financial crisis caused a sharp decline in the rates.
Government money rates can be impacted by a number of risk variables, including inflation,
economic growth, financial circumstances, and employment levels. The FOMC lowered interest
rates in response to the recession of 2001 in an effort to fight inflation and boost the economy.
The economy was at risk from the unemployment rate increasing to 6.3% in 2003. The cost of
fighting The War on Terror was also a risk factor that had a negative impact on the economy
since less money was allocated to infrastructure and more money was spent on defense
(Amadeo, 2021).
The real estate bubble and financial crisis, which led to a worse economic collapse than the Great
Depression, were additional risk factors. The federal funds rate was reduced by both crises to
historically low levels of almost 0%. These rates were established in response to the country's
economic crisis. At the same time, in 2009, mortgage interest rates reached an all-time low of
5.04%. (Miller, 2021). Interest rates remained low for a large portion of the following decade
throughout the protracted and gradual restoration.
The economy was already under duress before the 9/11 terrorist atrocities. The stock market was
closed for the first time since the Great Depression, which caused the DOW to decline by 700
points. On September 17, when the stock market reopened, the DOW instantly fell 7.13%, the
largest one-day decrease in history. They lost 1.4 billion dollars due to a four-day airline
stoppage, and the assaults as a whole cost the sector $5 billion. President Bush signed $15 billion
in federal financing for the airline corporations after airline workers were furloughed and 1,000
flights were halted (Amadeo, 2021).
The GDP decreased by 4.3% in 2007, the most notable loss since the end of World War II, later
in that decade. However, the GDP fell even more significantly in 2008, falling 6.3% in the final
three months of the year. This resulted from decreased consumer expenditure, which saw a 22%
decline in the purchasing of expensive products. During this time, exports also decreased by
24%. (Isidore, 2009). The unemployment rate reached 10% in October 2009 (Rich, 2013). Where
unemployment was highest may be seen on the federal funds rate graph as interest rates fell to
their lowest levels ever. The graph of 30-year mortgage interest rates also shows that in 2009,
when rates were historically at their lowest, unemployment reached their highest point.
The Fed is in charge of making monetary choices that promote maximum employment, maintain
inflation stability, and restrain long-term interest rates. The FOMC may decide to decrease
interest rates if the economy appears to be slowing down in order to encourage companies to
increase hiring and investment (Foster, 2021). Due to a mismatch in the growth rates of
aggregate demand and supply, interest rates increased at the turn of the century. As a result, the
FOMC opted to tighten monetary policy when it convened at the beginning of 2000 since there
was little indication that raising interest rates would bring supply and demand into balance
(Monetary Policy, 2000).
The housing crisis and the 9/11 terrorist attacks caused unemployment to surpass 10% in October
2009. (Rich, 2013). To save expenses, businesses were compelled to fire employees. Despite the
fact that interest rates were low, businesses were encouraged to borrow more money to grow.
During the first decade of the new century, productivity growth was aided by the development of
information technology (IT) and the increasing use of the internet. Productivity fell in several
other areas throughout this decade, including the aviation and service sectors, which contributed
to the sluggish economy (Spotlight on Statistics, 2021). Despite the FOMC maintaining interest
rates at historic lows, the Great Recession's high unemployment rate was caused by the crisis's
economic unpredictability (Schanzenbach, 2016).
The figure shown demonstrates the ad hoc link between the federal funds rate and the interest
rate on a 30-year mortgage. The consumer benefits when the FOMC reduces the federal funds
rate. While lower federal funds rates won't affect the fixed-rate mortgage's monthly payment,
they will result in reduced interest rates for prospective home purchasers. Since the federal funds
rate sets their rate, adjustable-rate mortgages (ARM) are more significantly impacted by changes
in the federal funds rate. These mortgages will have their payment cut if the rate is dropped. On
the other side, the homeowner's mortgage payment will increase if the federal funds rate is raised
(Canady, 2021).
Economically speaking, the first ten years of the new century were turbulent. The economic
decline was sparked by the Dot Com bubble, which was followed by the 9/11 terrorist attacks.
While many other businesses experienced pressures from the financial crisis during this decade,
the technology industry saw growth. The House Crisis, which resulted from lax bank lending and
decreasing housing prices, caused approximately 10 million people to lose their homes and 10%
unemployment in 2009.
In order to assist in the Global Recession intervention, the Federal Reserve took actions in 2008,
including lowering interest rates and rescuing the financial system through the Troubled Asset
Relief Program (TARP) and quantitative easing. The Fed urged Congress to adopt TARP as it
became obvious that the collapse of financial institutions would be expensive, allowing
investment banks like Goldman Sachs access to low-cost overnight financing. The fundamental
goal of this was to make it possible for all financial institutions to borrow money at affordable
rates (Yglesias, 2015).
Quantitative easing, which involved the Fed acquiring long-term debt issued by the federal
government such as Freddie-Mac and Fannie-May, was another unusual strategy used by the Fed
to interfere in the Financial Crisis (Yglesias, 2015). Although these strategies may have
prevented the US from going through a more severe recession, the recovery process was
nonetheless drawn out and unpleasant. The final part of the decade revealed a recession worse
than The Economic Depression, despite the fact that the economy appeared to be coming around
in the middle of the decade.
