25th October 2020

Confidant Classes

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The US Federal Reserve Interest Rate

The US Federal Reserve has reaffirmed its intention to keep benchmark interest rates close to zero until at least 2023 and to adjust to periods of rising inflation, in what is seen as a shift in the tailor-made central bank, it goes from the task of stabilizing financial markets to stimulate economic growth.

  • In the September policy statement and economic projections released on Wednesday, Fed Chairman Jerome Powell and his colleagues signaled their intention to be extremely patient as they attempt to revive the U.S. economy in the near future months to come.
  • The Federal Open Market Committee (FOMC) that sets the Fed’s rates said in a statement that the panel “expects it to be appropriate to maintain this target range until labor market conditions have reached levels consistent with the Employment Committee’s estimates, and inflation has risen to 2% and is on track to moderately exceed 2% for some time.

What is the heart of the new guide?

The new direction is based on a change in monetary policy that was first signaled by the Fed in June, which aims to neutralize years of low inflation and will allow the US economy to counter the sluggish labor market. induced by the pandemic.

  • The Fed also used the policy statement to signal a shift from stabilizing financial markets to stimulating the economy, saying it will keep its current purchases of government bonds at least at the current rate of $ 120 billion. dollars per month, in part to ensure an “accommodating” financial situation.
  • The virus is “causing enormous human and economic hardship,” and the Fed is “determined to use its full range of tools to support the US economy during this difficult time,” the FOMC said.
  • The new economic projections released with management’s policy statement that interest rates have been held in abeyance until at least 2023 and that inflation is not expected to exceed 2% during that time.
  • “Indeed, what we are saying is that rates will remain very accommodating until the economy is well advanced in its recovery,” said Fed Chairman Jerome Powell, quoted by Reuters.
  • “This should be a very powerful statement to support economic activity” and bring inflation back to the Fed’s 2% target faster, said Powell, adding that he believed the future directions would be “sustainable.”
  • The pace of the recovery is expected to slow, which will require continued support from the Fed and more government spending, he said.
  • Following the policy announcement, the dollar appreciated against a basket of currencies of major trading partners.

Does this change the political position?

The Fed’s position and the FOMC’s action are based on the policy directions and projections made three months ago. At their June meeting, the 17 Fed political representatives projected a federal funds rate close to zero, the key rate the Fed is targeting in implementing its monetary policy, for this year and next.

“We’re not thinking about raising rates, we’re not even thinking about raising rates,”

Powell told reporters after the June meeting, a maxim he has used several times since.
  • The Fed “is confident and determined and determined” to slightly exceed 2% inflation, even if it would take time, Powell said.
  • New projections indicate that the US economy could contract 3.7% this year, far less than the 6.5% contraction expected in June; It will be analyzed that unemployment, which was 8.4% in August, rose to 7.6% at the end of the year.
  • The 17 Fed policymakers saw interest rates stay where they were until 2022, and four projected the need for a rate hike in 2023.

What does all this mean?

By deciding to keep rates low until, or even after, inflation exceeds the 2% target, the Fed has pledged to boost GDP and job growth, announced in the form of fines, last month after a review of almost 2%. years.

  • The Fed kept rates close to zero for seven years during and after the 2008 financial crisis, before raising them in December 2015.
  • Over the past 10 years, it has taken more than three years for the adjusted GDP inflation returns to the level that prevailed before the global financial crisis.

How does the Federal Reserve affect inflation and employment?

Like other central banks such as the Reserve Bank of India, the Federal Reserve of the United States conducts its monetary policy, mainly influencing employment and inflation by using policy tools to control availability and Disponibility cost of credit in the economy.

  • The Fed’s main monetary policy tool is the federal funds rate, whose changes influence other interest rates, which in turn influence borrowing costs for households and businesses, as well as more financial conditions. general.
  • For example, when interest rates fall, it is cheaper to borrow, so households are more willing to buy goods and services, and businesses can grow by buying goods and equipment.
  • They can also hire more workers, affecting overall employment. Higher demand for goods and services can increase wages and other costs, which in turn affects inflation.
  • During a recession, the Fed can lower the federal funds rate to its lower limit close to zero. If more support is warranted, you can use other tools to influence financial conditions. Although the links of monetary policy to inflation and employment are neither direct nor immediate, monetary policy is a key factor.

What will be the impact on emerging market economies, including India?

In theory, a sign of continuing lower rates in the United States should be positive for emerging market economies (EMEs), particularly from a debt market perspective. Emerging economies like India tend to have higher interest rates and inflation than developed countries. As a result, the IFIs would like to borrow from the United States at low interest rates in dollars and invest that money in bonds of countries like India in rupee terms to obtain a higher interest rate.

  • When the Federal Reserve keeps interest rates low, the difference between the two countries’ interest rates increases, which makes countries like India more attractive for the currency carry trade.
  • A signal of lower rates from the Fed would also mean a greater boost to growth in the United States, which could be good news for global growth. But it could also translate into more equity investment in the United States and dampen investor enthusiasm for emerging market economies.
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