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The Fed manipulates interest rates in an attempt to stabilize the economy. The strategy goes something like this: slowly raise interest rates while the economy

The Fed manipulates interest rates in an attempt to stabilize the economy. The strategy goes something like this: slowly raise interest rates while the economy is humming along, and when a downturn comes along they quickly lower them in an attempt to boost the economy [0]. One of the dangers inherent in this strategy comes in the timing of the rate manipulations. Be too aggressive with raising rates and you may lose large amounts of economic momentum. Be too slow to raise rates and you may have nothing to lower in the event of a recession. So if China sold off a ton of US debt and it negatively affected the world economy, the Fed would likely cut interest rates in an attempt to counter the downturn. [0]: https://www.macrotrends.net/2015/fed-funds-rate-historical-chart https://www.macrotrends.net/2015/fed-funds-rate-historical-c...

panarky 8y ago
When you say "manipulate" you need to be clear about the mechanism. The Fed doesn't just dictate interest rates, because who would listen to them? Instead, interest rates are set by the market. If the Fed wants higher interest rates, they sell bonds in the market. If they want lower interest rates, they buy bonds in the market. So if China sold a ton of US debt, that would reduce bond prices and increase interest rates. If the Fed wanted lower interest rates, it would need to buy a lot of that additional supply that China dumped on the market.
- colemannugent 8y ago
  >interest rates are set by the market Aye, mostly. It's important to remember that the Federal Govt. has the ability to manipulate the money supply by printing money and the ability to nearly indefinitely borrow whenever they get into trouble. Note that borrowing implies issuing bonds, which will lower interest rates. So the Fed cannot simply dictate interest rates, but if it wants to manipulate the rates there is not a whole lot stopping them. In a recession scenario I imagine they would not have much trouble justifying more borrowing to the American public. With regard to the effect a Chinese selloff would have on the market (both the US bond market and the wider global economy) I don't know enough to comment. However, I am fairly confident that if such a selloff resulted in a major economic downturn the Fed would try to lower rates to stimulate the economy.
  - panarky 8y ago
    > borrowing implies issuing bonds, which will lower interest rates You have it exactly backwards. Issuing bonds means selling bonds. Selling bonds or anything else puts downward pressure on the price. When price of a bond falls, its yield (interest rate) rises.
    - colemannugent 8y ago
      >You have it exactly backwards. Whoops! You're exactly correct. Issuing more bonds increases the risk of the issuer not being able to repay the debt and thus the debtors will demand higher rates to offset this increased risk. Although, unlike other bond issuers, the Fed has other tools in it's arsenal that would allow it to manipulate the yield curve.

panarky 8y ago

When you say "manipulate" you need to be clear about the mechanism. The Fed doesn't just dictate interest rates, because who would listen to them? Instead, interest rates are set by the market. If the Fed wants higher interest rates, they sell bonds in the market. If they want lower interest rates, they buy bonds in the market. So if China sold a ton of US debt, that would reduce bond prices and increase interest rates. If the Fed wanted lower interest rates, it would need to buy a lot of that additional supply that China dumped on the market.

colemannugent 8y ago
>interest rates are set by the market Aye, mostly. It's important to remember that the Federal Govt. has the ability to manipulate the money supply by printing money and the ability to nearly indefinitely borrow whenever they get into trouble. Note that borrowing implies issuing bonds, which will lower interest rates. So the Fed cannot simply dictate interest rates, but if it wants to manipulate the rates there is not a whole lot stopping them. In a recession scenario I imagine they would not have much trouble justifying more borrowing to the American public. With regard to the effect a Chinese selloff would have on the market (both the US bond market and the wider global economy) I don't know enough to comment. However, I am fairly confident that if such a selloff resulted in a major economic downturn the Fed would try to lower rates to stimulate the economy.
- panarky 8y ago
  > borrowing implies issuing bonds, which will lower interest rates You have it exactly backwards. Issuing bonds means selling bonds. Selling bonds or anything else puts downward pressure on the price. When price of a bond falls, its yield (interest rate) rises.
  - colemannugent 8y ago
    >You have it exactly backwards. Whoops! You're exactly correct. Issuing more bonds increases the risk of the issuer not being able to repay the debt and thus the debtors will demand higher rates to offset this increased risk. Although, unlike other bond issuers, the Fed has other tools in it's arsenal that would allow it to manipulate the yield curve.