Podcast
Questions and Answers
What does EONIA stand for?
What does EONIA stand for?
Negative interest rates mean that banks earn money by lending to each other.
Negative interest rates mean that banks earn money by lending to each other.
False
What is one reason banks may choose to lend money at negative interest rates instead of holding cash?
What is one reason banks may choose to lend money at negative interest rates instead of holding cash?
It is costly to store cash.
Eugen Bohm von Bawerk, in his book on capital and interest, suggested that interest rates tend to be small positive numbers due to ______, time preferences, and advantages to round aboutness.
Eugen Bohm von Bawerk, in his book on capital and interest, suggested that interest rates tend to be small positive numbers due to ______, time preferences, and advantages to round aboutness.
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Match the following concepts with their descriptions:
Match the following concepts with their descriptions:
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How long has EONIA been negative?
How long has EONIA been negative?
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Cutting interest rates has the same effect on all economic participants.
Cutting interest rates has the same effect on all economic participants.
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What is the primary purpose of the Federal Funds Rate?
What is the primary purpose of the Federal Funds Rate?
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Individuals typically borrow money at the Federal Funds Rate.
Individuals typically borrow money at the Federal Funds Rate.
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In what year did the Federal Reserve begin to raise interest rates after a period close to zero?
In what year did the Federal Reserve begin to raise interest rates after a period close to zero?
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The European counterpart to the federal funds rate is called __________.
The European counterpart to the federal funds rate is called __________.
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Match the following terms with their definitions:
Match the following terms with their definitions:
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What was the condition of the Federal Funds Rate during the economic crisis?
What was the condition of the Federal Funds Rate during the economic crisis?
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The Federal Reserve's main goal is to set interest rates at a level that encourages borrowing.
The Federal Reserve's main goal is to set interest rates at a level that encourages borrowing.
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What did the behavior of the Federal Funds Rate indicate about the economic situation?
What did the behavior of the Federal Funds Rate indicate about the economic situation?
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Study Notes
Federal Funds Rate
- The Federal Funds Rate is the shortest term interest rate in the U.S., reflecting an overnight borrowing cost primarily used by banks.
- Since the 2008 financial crisis, the Federal Funds Rate has remained around zero, with recent slight increases indicating potential economic recovery.
- Predictions of interest rates can be challenging; past forecasts did not anticipate such prolonged low rates.
Comparisons with Europe
- EONIA (European Overnight Index Average) is the European counterpart to the Federal Funds Rate, reflecting overnight lending rates between banks in Europe.
- EONIA has experienced negative rates for over a year, showcasing a longer trend of falling interest rates compared to the U.S.
Negative Interest Rates
- Negative interest rates occur when banks are charged to hold reserves, making lending less appealing; banks may prefer to lend at a negative rate rather than store cash.
- Costs associated with holding large amounts of cash include insurance and security due to theft risks.
- The current average EONIA rate is approximately -0.30%, indicating a willingness to lend despite negative yields.
Historical Context and Economic Theories
- Interest rates are influenced by factors such as technological progress, time preferences, and production advantages as originally articulated by Eugen Bohm von Bawerk in his 1884 book "Capital and Interest."
- Traditional expectations set rates around 3% to 5% due to the anticipated economic growth and time preferences that favor present consumption over future returns.
Impact on Inequality
- Low interest rates can exacerbate economic inequality, particularly affecting retirees dependent on fixed income from interest, which diminishes during low-rate environments.
- Policy measures like low-interest rates are blunt tools that may not benefit all demographics equally, raising concerns about widening inequality.
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Description
This quiz explores the concept of the Federal Funds Rate, focusing on its definition as the overnight interest rate in the United States. It discusses its significance, particularly for banks and financial institutions, and examines the implications of short-term interest rates for the economy.
