Economic Scenarios
Higher interest rates, more capital invested
During the 1980s, when President Reagan was attempting to stimulate the economy, he radically lowered taxes. The U.S. was in the grips of ‘stagflation,’ or high unemployment and high inflation, a combination which historically is not supposed to occur together. The lower corporate taxes and lower taxes for wealthy individuals eventually encouraged more investment in business. “The Fed was resolved to stop inflation[and] kept raising rates in 1980 and ’81, eventually bringing both the economy and inflation to a standstill” (Solomon 2009). By the mid-80s, interest rates were still high, but investment capital in the economy had increased.
Lower interest rates, less capital invested
Low interest rates and low rates of capital invested in the economy are usually characteristic of a recession. This occurred very recently, during the Great Recession of 2008, when the Fed slashed interest rates to historically low levels to stimulate growth. “The Federal Reserve surprised Wall Streetby cutting its interest rate target by three-quarters of a percentage pointThe move had the effect of reducing rates on mortgages and , and reassured investors that the Fed will do what it can to spur economic activity as long as the threat of recession looms” (Barr 2008). However, despite this encouragement to banks to lend money, there has been a widespread reluctance amongst many businesses to expand and hire more workers.
Lower interest rates, more capital invested
In the 1990s interest rates were much lower than they had been in the 1980s, but the economy was booming and more capital was being invested in the economy, partially as a result of the revolution in technology that came to be known as the dot.com boom (and bust). After the economic bubble began to deflate in 2001, the Fed lowered interest rates so much that a housing ‘bubble’ manifested, and more and more people invested in real estate in hopes of turning a profit. For a different reason, interest rates were very low during . “During World War II, the Fed concentrated on maintaining ‘low’ interest rates so that the U.S. Treasury could sell enough bonds to finance the war.his policy pumped large quantities of inflationary new money into the monetary system. To hide inflation, the administration and Congress imposed direct controls on prices, wages, and production” (Timberlake 2008).
Higher interest rates, less capital invested
High interest rates with relatively low levels of capital were characteristic of the early 1980s; right after the Fed dramatically increased interest rates to curtail inflation. The U.S. went through a severe recession before the economy began to recover (Solomon 2008).
Which of these four scenarios are most important today? Which scenario is most conducive toward economic growth? Which scenario is the most normal historically?
Today, interest rates are low, but there is relatively little capital being invested because of concern about the economy. The scenario most conducive to economic growth are low interest rates and high levels of capital investment, which means that it is cheap to borrow and there are many incentives and opportunities to invest in expanding enterprises. In general, in America it has been more common for interest rates to be relatively high to combat inflation (given that prices are almost always going up) combined with relatively high rates of capital investment.
References
Barr, Colin. (2008). The darker side of interest rate cuts. CNN. Retrieved:
http://money.cnn.com/2008/01/24/news/economy/barr_interest.fortune/
Solomon, Paul. (2009). What led to the high interest rates of the 1980s. PBS.
http://www.pbs.org/newshour/businessdesk/2009/05/what-led-to-the-high-interest.html
Timberlake, Richard. (2008). The System. The Concise Encyclopedia
of Economics. Retrieved: http://www.econlib.org/library/Enc/FederalReserveSystem.html
