Why Fed is going to do so ?
The Federal Reserve is the central
monetary authority to the largest economy of the world, the USA. After the pandemic
of the COVID-19 almost all the countries experienced a slowdown in the economic
growth and the USA being one of the largest economies, was not free from its
impact. The general rule of Economics is that whenever the economy is alarmed
to the situation of the crisis such as asset bubbles, hyperinflation, or any
economic catastrophic crash downs, the central monetary authority (Fed in the
USA and NRB is Nepal) tends to raise the interest rate so as to ensure the
economic and financial stability. Doing this could help the economy move on its
track.
Controlling the interest rate is one of
the significant tools for which any central bank has privilege to deal with it.
The governor (popularly known as the Chair) of the Federal Reserve, Jerome
Powell on December 15, 2021 proclaimed to increase the Federal Funds Rate (also
called as the Federal funds target rate) for the coming economic time. Powell
seemed quite confident to set a target range for the federal funds rate through
the meeting of the Federal open market committee. This rate would be the rate
of reference or the base rate for the commercial banks to charge on their overnight
loans. The average of the rates that banks negotiate for the overnight loans in
the effective federal funds rate. This is seen to impact the other rates such
as, the SOF rate and the prime rate.
Why do we bother if Fed raises the interest rate?
We must do it, because, as we know, this
change in the interest rate by Fed can influence the interest rate throughout the
global economy. It is a general rule of economics that when the interest rate
in increased the cost of credit is also increased and it definitely impacts the
entire economy. And the impact is assessed when every business tycoons and even
people spend more of their money for the interest payments. Those who do not
take the courage to pay such higher interest rate, they for sure, postpone
their projects or their business undertakings and financing. This can lead
people to save money for the higher interest payments. This eventually tends to
decrease the supply of the money or the flow of credit in the economy and help
curb the inflation. One of the reason behind Fed is doing this is also to
control inflation in the future which is skyrocketing these days (6.8 percent –
November, 2021).
Impacts into the various sectors and economic domain
The impacts of it on
various sectors is resembled as –
·
Impact on Stock
According to the rule
of thumb, higher market interest rate lays a negative impact on the stocks. The
cost of doing business raises for the general people and business tycoons rises
when the borrowing is very expensive. The higher value of costs and less growth
of the businesses results in the low growth of the revenue and eventually the
price of the stock declines. Some social psychologist proclaim that the rate
surge can affect the market psychology and as far as the trading is concerned
the traders can immediately sell the stocks to move towards the defensive investments.
This can create distortions in the stock market indices.
·
The impact on
the Bond
The market prices of
the existing bonds decline quickly when the Fed announces the increase in the
interest rate. This is generally because the new bonds will be soon coming into
the market that will offer investors higher interest rate payments. For the
reflection of the higher overall rate, the existing bond will decrease in price
and that will eventually lead for the low interest rate payments attracts the investors
even more. The economist Chan quotes that the inflation also degrades the
actual face value of the bond, which seems to be the particular concern for the
longer maturity debts.
·
Impact on the
Saving Account and Deposits
The people with a
saving account can be quite happy with the surge in the interest rate. Because
in the USA the funds rate of the Fed is also a benchmark for a deposit account’s
annual proceedings yields. Whenever the open market committee raises the rates
banks increase the amount that people earn from the deposit accounts. The annual
percentage yield that people earn on the savings accounts, checking accounts, certificate
of deposit, and money market accounts also rises to the higher level. The
online savings accounts are more reacting to the increase in the Fed rates due
to the fierce competition for the online deposits among the online banks. However,
the annual percentage yields by conventional bricks and mortar banks respond
very slowly to the increase in the Fed rates.
·
Impact on the
credit to the consumer
The consumer credits
like personal loans, line of credit, credit card, respond more quickly to the
increase in the Fed rates. The Fed rate is also more sensitive to the variable rate
loans as the interest rate charge are in with the base with the federal funds
rate.
Impact on Nepalese economy
The Nepalese economy is heavily reliant on the
Indian Economy and the Chinese economy and relationship with the economy of the
USA (only 1.2 percent of the total trade of Nepal with the world is in trade
with USA), it is in a very small amount. However, major companies in the USA
and their brands which are sold in Nepal are surely going to be affected by
this. We can also say that it can affect the External Commercial Borrowings in
Nepal from the USA. The research is yet to be done in detail regarding this.
Note: Please, laud with comments.
Thank
You
Aditya
Pokhrel
MBA,
MA Economics, MPA (rng)
Asst.
Director
Nepal
Rastra Bank (the central bank of Nepal)
References: Speech by the Chair, Jerome Powell – The
Federal Reserve (2021)
Connell and Curry (2021) – Economists at
Forbes
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