by Ms. C. Jones

Created on: January 01, 2009   Last Updated: January 04, 2009

There are five reason why the Fed will not raise interest rates in the current financial crisis. First, lending rates show that there is still a credit crunch. A credit crunch is an economic condition in which investment capital is difficult to obtain. Banks and investors become wary of lending funds to corporations, which drives up the price of debt products for borrowers.

A credit crunch makes it nearly impossible for companies to borrow money because lenders are scared of bankruptcies and default. The results are the economy is slower to recover. This happens because of the decline in the credit supply.

The entire banking system around the world is fragile. Banks in the United States, the United Kingdom, Japan and Sweden had to be bailed out. The US alone agreed to a $700 billion dollar bailout plan. Banks are still in a fragile state and are not lending as much money as they used to. There is still no direct proof that the bailout plan is even going to work. If the Fed decided to raise interest rates then the USA could fall even deeper into a recession. We have seen the fall of some of America's oldest and richest banks, Lehman Brothers, Fanny Mae and Freddie Mac

The rise in energy prices has lead to an increase in all sectors of the economy. Food prices increased by up to 65% in some countries because of many natural disasters such as flooding. This lead to rice and soybean prices increasing drastically. Money that would be spent in other sectors is now being spent on food. Food prices force substitution, just like energy prices.

The housing situation around the world still poses a real threat. Falling housing prices continue around the United States. If the Fed increased interest rates then it would only make the housing situation worse. There are millions of available housing units. Short term rates must be held steadily in order to stave off defaults and foreclosures on mortgages.

The flattening yield curve could pressure bank profits. The graph of bonds in the treasury market usually slope upwards, with yields on longer-term bonds higher than shorter maturities to compensate investors for taking an additional risk on long term bonds. Long term bonds have not been rising despite efforts from the Fed in which they increased the bank lending rate from 3.25% from 1% just a little over a year ago. If there is a flat yield curve then investors are not really being compensated for taking greater risks. Most investors would sell off their longer term bonds for short-term ones.

As it stands, the entire world economy is highly vulnerable. 2009 will be a very volatile year for the stock markets, investors and banks. The present state of the world economy is unprecedented. There is a very good chance that the bailout plan will not work. We hope that the Fed will continue to keep interests rates low so that the economy can slowly begin to recuperate.

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