Fed Policy

Fed Policy

Subject: Economy

Context:

The Federal Reserve on Wednesday raised the key US interest rate again and signalled more hikes–an aggressive stance that has raised fears of an eventual recession.

Details:

• The increase takes the policy rate to 3.0-3.25% rates and would reach 4.4% by the end of 2022 and 4.6% in the next year–a more hawkish shift.
• Policy makers expect rates will be cut in 2024, to about 3.9%, and to 2.9% in 2025.

Fed Reserve and the Monetary Policy:

• Monetary policy in the United States comprises the Federal Reserve’s actions and communications to promote maximum employment, stable prices, and moderate long-term interest rates–the economic goals the Congress has instructed the Federal Reserve to pursue.
• The Federal Reserve Act of 1913 gave the Federal Reserve responsibility for setting monetary policy.
• The Federal Open Market Committee FOMC’s primary means of adjusting the stance of monetary policy is by changing its target for the federal funds rate.
  • The federal funds rate is the interest rate at which depository institutions lend balances at the Federal Reserve to other depository institutions overnight.
• The FOMC has the ability to influence the federal funds rate–and thus the cost of short-term interbank credit–by changing the rate of interest the Fed pays on reserve balances that banks hold at the Fed.
  • A bank is unlikely to lend to another bank (or to any of its customers) at an interest rate lower than the rate that the bank can earn on reserve balances held at the Fed.

Impact:

• Rise in lending rates-Federal funds rate changes are rapidly reflected in the interest rates that banks and other lenders charge on short-term loans to one another, households, nonfinancial businesses, and government entities.
• Rise in deposit rate and other returns-The rates of return on commercial paper and U.S. Treasury bills–which are short-term debt securities issued by private companies and the federal government, respectively, to raise funds–typically move closely with the federal funds rate.
• Capital inflows to the US-relative rise in interest rate leads capital outflows from other countries into the US.
• Appreciation of dollar and depreciation of other currency-Changes in the relative attractiveness of U.S. assets will move exchange rates and affect the dollar value of corresponding foreign-currency-denominated assets (appreciation of dollar)
  • The rupee depreciated to close at an all-time low of 80.86 against the US dollar after the US Federal Reserve’s interest rate hike and its hawkish stance.
    • Rupee along with other Asian peers tumbled to a record low.