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August 07, 2006

An interest rate rule

Economists and others are always trying to predict what the Federal Reserve will do with interest rates. N.C. State University economist outlines one simple rule economists use to predict the Fed’s next move.

“This is a little bit of inside baseball –- or inside economics -– but it does have a lot of practical relevance because, of course, higher interest rates or changes in interest rates really affect everyone,” Dr. Walden says. “So economists especially are always trying to guess what the Fed is going to do with interest rates.

“And one of the rules is … that what’s called the neutral interest rate –- the interest rate set by the Fed that’s not going to have an impact on the economy -– will be equal to the rate at which the economy is growing plus the inflation rate.

"And if the Fed moves their interest rate above that calculated rate, that means they are trying to slow down the economy. If they move the rate that they control under that calculated rate, that means they are trying to increase growth in the economy.

“Now, if you use that rule and you look at where the Fed has set interest rates right now, it appears to be right about normal or neutral,” he adds. “And so what many economists are predicting is that the Fed will probably push rates up a little bit more -– maybe one more rate hike –- and that will be it.

“So this is something we can use to perhaps look forward to and guess, in a sophisticated way, what the Fed is going to do.”

Posted by deeshore at August 7, 2006 08:00 AM