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Chapter 10. What Moves the Markets: Basi... > Monetary Policy and Interest Rates

Monetary Policy and Interest Rates

As mentioned, some central banks can lower or raise short-term interest rates in a bid to control the nation's money supply. In simple terms, lowering interest rates makes it cheaper to borrow money, thus stimulating consumption and economic growth. The run-up in auto sales and home prices in the U.S. in 2002 and 2003 was due mostly to Alan Greenspan's decision to lower interest rates six times, first in response to the stock market crash of April 2001 and then because of the terrorist attacks in September of that same year. Generally, the markets react favorably to cuts in interest rates and fearfully when rates are raised.

But there are several other factors to consider. Free credit expands the money supply and puts more dollars in wallets. With more dollars chasing goods and services, the law of supply and demand inevitably goes into effect. Prices rise and may spark inflation. If a currency is losing value through inflation, it will suffer in the currency markets. Consequently, raising rates can be greeted with relief, or it can be seen as too little, too late and confirm traders' fears that inflation is setting in.


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