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Tuesday, February 24, 2015

The Economy Moves from Unemployment to Increasing Wages

As the economy speeds up  Federal Resereve Chair Janet Yellen discusses the growing need to increase interest rates. For now the idea will be reevaluated on a meeting-by-meeting basis to determine when that might happen. Her discussion with the Senate Banking Committee eludes to the idea that her annual target rate will be somewhere around 2% depending on the strength of the economy. For the near future the economy is expected to continue growing. 

The market forces related to the speed of the economy will determine these rates. Interest rates are the cost of borrowing money and is primarily based on demand and supply. As money is soaked up in the economy it becomes less liquid and shortages begin to raise the cost of borrowing that money to mitigate risks.

For example what you pay for a car today would cost you more tomorrow as the product price rises. You wouldn't get that money for free without paying some type of interest on it as the lender takes risks. Getting money today without having to save it yourself must have some cost in case it isn't paid back.

The government sets these rates through manipulating the federal fund rate that large institutions use to charge each other when borrowing money. When government buys securities they flood banks with money and when they sell securities they take money away from the market. The value of that money is impacted by its availability and fluidity.

The government considers adjusting the interest to make sure that inflation doesn't rise too rapidly and choke off employment. However, with unemployment at low levels rising inflation will help push wages upwards better balancing growth income and economic growth. For the moment it appears that unemployment has been solved for many people in society and government is no longer worried about it as much as they were in the past.

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