For the economists - Why would you raise interest rates when economy is doing bad?

Question

We know that by raising interest rates, you make the cost of borrowed money more expensive. Business thrive on borrowed money, and doesn't it follow that, if you raised interest rates, this will make it harder for business to expand?

Answer 1

The effect is not immediate.

Answer 2

interest rates are used to combat inflation as well.  So when the economy is not doing well, and also showing signs of inflation, you have to raise interest rates, and find other ways to stimulate the economy.  typically with tax breaks or public works projects, military spending or a combination of all three

Answer 3

Raising interest rates has the effect of cooling off the economy.  A hot, or run away, economy is not a good thing either.  An increase in interest rates tends to reduce inflation, e.g., the cost of a loaf of bread in post WW I Germany was 20,000 marks.  Later the same day, the same loaf of bread may have cost 5,000,000 marks.  (Encyclopedia Brit.)

Yes, a tighter credit market will deter businesses from expanding if, and only if, investors withhold investing in those businesses.  However, it seems that the US economy usually averages about a 10% annual return.  That's not bad.  Over the previous 6 years foreign fund investment has seen phenomenal returns.  Now it is time to return to normal.

Answer 4

economists don't raise interest rates, they only calculate and opine.

the Federal Reserve created by Congress in 1913 is a quasi-private entity governed by a board which consists largely of economists of variable sanity, appointed by politicians.

The Fed was empowered to create money and to manipulate the economy by Expanding or Contracting the money supply.   The Fed has become the "Central Bank" of the USA, the place where bankers can borrow new money created by the fed.

Expansion is accomplished by the Fed lowering interest rates for the bankers at the Fed window.  Expansion, the increasing of the money supply, beyond true real growth and real assets is Inflationary.

Contraction is accomplished by the Fed increasing interest rates.  That manipulation is used to "slow down an overheated economy".  Ironically, any overheating resulted from the earlier Expansion!  

The result, of course, is an unstable economy, which is today on the brink of collapse because of inflation.  Inflation hurts everyone, barring them from realizing real return from savings and investment.

Answer 5

it depends on the combination of factors that make it a bad economy.

high inflation with normal GDP growth

low inflation with no GDP growth

high inlfation and no GDP growth

All these combinations are scenarios of a bad economy, so the Fed or national bank would make a decision depending on which is the case between these scenarios.  

The fact is, that no one entity sets interests rates, the market does, the Fed and other national banking systems set rates for some transactions, but most interests paid in a country will be on a market conditions.

Answer 6

The current problem is that because too many loans were made for customers who were not qualified, a lot of homes are in foreclosure which means that the banks are left holding properties that are valued at less than their market value.  This is making the banks more reticent to lend money including businesss.  So this means that money has essentially become more scarse.  Currently because of other factors, the economy is in a downward spirals so there are no ways for businesses to expand.

Answer 7

To say that "economy is doing bad" is to say nothing.  There are two specific ways for the economy to be "doing bad".  You can have a high inflation or a high unemployment.  To fight high inflation, you raise interest rates; to fight high unemployment, you lower interest rates.  The big problem, of course, is stagflation -- a situation when both inflation and unemployment are high, so one cannot be fixed without making the other worse, at least temporarily.