Monetary systems and interest rates

Monetary systems and interest rates

Introduction

Every nation has and needs a monetary system to control supply and money value in a country. In the early years, the United States used a gold standard financial system; then, it later faced harsh criticism from some of the nation’s especially the United States of America, at around the late twentieth century (Cassel, 2017). This paper aims at defining what is the gold standard and also shedding light on the matter of why the golden rule was made away within the United States of America. It also will explore whether or not it was better than the current FIAT system.

A gold standard is a monetary system money paper is directly linked with a fixed amount of gold. In this system, the monetary unit is defined by a certain amount of gold. A given amount of gold was equated with a given amount of paper currency (Willson, 2017). The requirement to redeem for gold guarantee was gold value for all kinds of bank issue-money. The purchasing power of gold currency was very stable.

The inflation rate during the error f this monetary system was meager and is maintained at that. In contrast, a currency that could not be redeemed to gold or other commodity had no value guarantee. This type of money is a fiat currency (Cassel, 2017).  Fiat currency leads the inflation rate from mild to terrible. The gold standard can operate with or without government intervention in the minting of golden coins, issuing of gold-backed paper currency and checking accounts. Reliable providers of gold-denominated money were private mints and commercial banks.

The united stated eradicated the gold monetary system as it contained the federal government form increasing money supply. Gold reserves were growing very slowly and the obligation to redeem to gold limited money printing; thus, they opted out this monetary system (Willson, 2017). They took two significant steps to go off the gold standard system. First, the federal government refused to redeem national reserved notes in cons for the citizens. Then they banned the use and private ownership of the gold coins where all individuals and banks were ordered to turn in all their gold coins (Learn Liberty, 2013). The federal rapidly printed more paper currency hence lowering the purchasing power of the dollar. It, therefore, increased redemption of the dollar by the foreign central bank, and eventually, we ran out of gold. Inflation rapidly raised to a double-digit due to the factors.

The only problem that would have faced gold standard was a random shock in supply and demand of the gold of which was not a significant challenge as the inflation rate was low, and the gold value was stable (Cassel, 2017). The federal open market committee is in charge of the current fiat standard, and they have no control to prevent inflation. Political appointees decide the fate of the dollar. The gold standard has dramatically outperformed fiat standards in controlling inflation and providing a stable currency.

Interest rates

Interest rates are the amount of money charged by the lender to the borrower from the proportion of the loaned amount. Interest rates refer to the amount of interest I a given period presented as a percent. Currently, the interest rates are meager, and hence more people can borrow. With the improvement of the economy, the federal needs to control the interest rates to prevent them from overheating using different tools (Koepke, 2018). They have come up with new tools to manage the interest rates as the previous did not work effectively. The feds primary tool is setting interest on excess reserves.

The fed funds rate is set considering the activities and lending and borrowing money between households and big banks. Big banks receive loans from the tenants to the big banks at lower interest rates, and the big banks then store the money the feds and earn interest at a higher price and pocket the difference (Cassel, 2017). The other toolkit is the reverse repo program. It is used when to solve the problem that occurs when interest on excess reserve (IOER) rises. The fed funds rate does not increase and fall along with the IOER; hence the reverse repo program is used (Koepke, 2018). Raising the interest rate of the feds and the big banks, the households still earn interest at the same lower rate; hence the other toolkit is used to balance the two.

Since the households accept to earn interest at a lower rate than the big banks, then the fed provides them with another place to take their money using the reverse repo program at a price set the fed (Wall Street Journal, 2015). Using this tool, the households can give funds to the big banks at a higher rate, consequently increasing the fed fund rate. This controls the interest rates between the bank’s standards and home loans, balancing the fed fund rates and the interest on excess reserves.

A mix of market forces and the fed monetary management come together to control the new economic error by applying their interest controls tools. By using the interest on excess reserve tool and the reverse repo program, the fed can set the pace and control interest rates (Mentari, 2019). The interest rates should not be too low since it may bring about an economic crisis, which May e lead to inflation. Also, it should not be very high as it may limit cash flow in the economy. Hence a balance of the interest rates is crucial.

Conclusion

To sum up, we understand the gold standard was used in the early days, even before the First World War. It is a monetary system that equated a given amount of gold with a fixed rate of paper currency. It controlled inflation and always guaranteed value. It was rubbed if in us by the federal as it contained them form supply more money, and they introduced fiat money, which drastically raised the inflation rare and never guaranteed value. Interest rates are presented as a percentage where the lender charges the borrower from the principal amount for a given period. The fed use interest on excess reserves and reverse repro program to control the interest rate.

References

Cassel, G. (2017). The downfall of the gold standard. Routledge.

Koepke, R. (2018). Fed policy expectations and portfolio flows to emerging markets. Journal of International Financial Markets, Institutions, and Money, 55, 170-194.

Learn Liberty (2013). What is the Gold Standard? https://youtu.be/LdyHso5iSZI

Mentari, N. M. I., & Artini, L. G. S. (2019). Market reaction as an impact of announcement increase fed interest rate in Asian and European areas. International research journal of management, IT and social sciences, 6(5), 210-217.

Wall Street Journal (2015). How Interest Rates Are Set: The Fed’s New Tools Explained. https://youtu.be/Oz5hNemSdWc

Wilson, T. (2017). Battles for the Standard: Bimetallism and the Spread of the Gold Standard in the Nineteenth Century. Routledge.