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Why do they say when the money supply increases does the interest rate rise? The fed does not determine the interest rate? the

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pohnpei397 eNotes educator | Certified Educator

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The Fed does not absolutely control the interest rate.  When the Fed raises its interest rates, banks will usually raise theirs so they don't lose money.  But if they Fed lowers theirs (like they did at the start of the financial crisis) the banks will not necessarily lower theirs.  The banks did not really want to loan at the start of the financial crisis (worried that the loans would go bad and they'd lose the money) so they didn't lower their rates.

If the supply of money increases, the interest rates really ought to go down.  Did you mistype that statement?

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krishna-agrawala | Student

Money supply influences the money that is available to the borrowers for conducting their business. One major factor affecting the money supply is the net savings by the people. Typically part of the total GDP of an economy is saved by the people which then put in bank accounts, fixed deposits or other types of bonds issued by financial institutions and governments.

It is not correct to say that money supply increase is always accompanied by increase in interest. All that we can say is that when interest rates increase there is greater incentive for people to save more. The saving by the people represents the primary source of borrowed fund, and therefore is substantially affected by interest rates.

Government does not exactly fix the interest rates, but many government actions in for of financial and fiscal policies, and the interest they offer on the bonds issued by them have substantial impact on the market interest rates.