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We like to think that when we deposit a dollar at the bank, it goes into a big vault and we can pull out that same dollar at any time. But that¿s not how the U.S. banking system works. Banks take that money and invest it to make money themselves, so cash gets spread around. This, naturally, leads to a big risk: What happens if those investments go sour? Well, you¿d be out of luck. You can¿t get your dollar back.
The Federal Reserve doesn¿t like that scenario, so it prohibits banks from putting all the cash it has on deposit on the line. In fact, the Fed forces banks to keep a portion of their assets at the Federal Reserve itself, to make sure that some of your assets won¿t get squandered if the bank¿s bets go south. These are called ¿reserves,¿ (hence, Federal Reserve. Got it? Good), and usually amount to 10% of the total cash kept in checking accounts.
These reserves are never exactly 10%, and banks like to keep a little extra in reserve ¿ not, as you might think, to make you more comfortable that they¿re in good financial shape, but rather so they can take that excess and lend it to other banks and make money off it. (They¿re banks, they can¿t help themselves.) The rate at which they make these loans is called the Federal Funds rate, which is set by the Federal Reserve¿s Federal Open Market Committee.
When you hear people chattering about how the Fed cut or hiked interest rates, this is what they¿re talking about: the interest rate banks can charge for lending money from their reserves. This begs the question: If these are essentially loans between banks, why is the Fed Funds rate so important for the rest of the economy?
Well, simply put, because loans make the financial world go round. Bank A lends Bank B $10,000 at a Fed Funds rate of 5%. Bank B then lends out $10,000 to a small business at 7%. The small business then takes that money and expands the business and hires new workers. Now someone is employed, Bank B has made interest off the loan, and Bank A is the richer for making it all happen. It¿s perhaps overly simplistic, but you get the idea. When you want the economy to thrive, you make lending cheaper.
Of course, sometimes you don¿t want the economy to thrive. In fact, you might want it to cool down, mostly to avoid money flooding the system and causing inflation. In that case, the Fed raises interest rates, making it difficult to lend or borrow.
Home / Markets / Economy
Wednesday, May 07, 2008
Worker Productivity Increases 2.2% in First Quarter
Associated Press
WASHINGTON--
Worker productivity rose by a better-than-expected amount in the first three months of the year while labor cost pressures eased.
The Labor Department reported Wednesday that productivity, the amount of output per hour of work, increased at an annual rate of 2.2% in the first quarter. That was slightly higher than the 1.5% increase which had been expected.
In a sign that inflation could be easing, labor cost pressures slowed a bit. Unit labor costs rose at an annual rate of 2.2%, down from a 2.8% rise in the final three months of last year.
While rising wages and benefits are good for employees, those increases can lead to higher inflation if businesses are forced forced to boost the cost of their products to cover the higher payroll costs.
However, if productivity is increasing it allows businesses to finance higher wages out of the increased output.
The Federal Reserve, which is always on guard about the threat of inflation, closely monitors developments in productivity since wage pressures are often the key way that inflation gets out of control.
The Fed last week boosted a key interest rate for the seventh time since September, but the increase was a smaller quarter-point move and the Fed signaled that it may pause its rate cutting campaign in part because of concerns about inflation.
Private economists believe the weakening economy will dampen inflation pressures. However, the sharp economic slowdown is occurring at the same time that energy and food prices have continued to rise.
Many analysts think that the country has already toppled into a recession. But overall economic growth, as measured by the gross domestic product, eked out a tiny 0.6% rate of increase in the first three months of the year, the same anemic pace as the final three months of last year.
The rise in productivity in the first three months of the year occurred as the number of hours worked declined at an annual rate of 1.8%.
That reflected layoffs that have been occurring as businesses have cutback on heir payrolls in the face of an economic slowdown that has been triggered by a steep slump in housing and a severe credit crunch that has resulted in billions of dollars of losses from financial firms.
The 2.2% rate of productivity growth in the first quarter was up slightly from a 1.8% increase in the fourth quarter of last year.
Productivity for all of 2007 rose by 1.8%, up a bit from the 1% gain in 2006. However, both of those increases were far below the growth levels of the past decade as productivity experienced a healthy rebound, reflecting all the investments that had been made in productivity-enhancing equipment such as computers.
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