The article is about the Federal Reserve and its decision to retain the current benchmark rate at between 2 and 2.25 percent. This decision is significant because many observers were keen on seeing the Federal Reserve’s response to the political upset in which the Democrats recaptured the House with regard to monetary policy.
There is increased optimism about the growth of the economy, and the Federal Reserve is keen on regularly reviewing rates upwards at a slow but steady rate towards next year. Currently, the Fed is increasing the rate by a quarter of a percentage point per quarter. The Fed also noted a decline in unemployment rates. Economic growth coupled with dropping unemployment rates has resulted in some Federal Reserve officials recommending that the rate is raised to restrictive regions in order to compensate for the likelihood that inflation will rise. Other officials, however, maintain that the rate of increase is too fast and risks resulting in a slowed economy because the impact of wage growth will be watered down. This leaves the Fed in a fix as it attempts to regulate inflation while trying not to cause an economic slowdown.
The decision by the Federal Reserve to maintain its current benchmark rate with intentions to continue raising it has several economic implications such as:
• Effects on the prime rate. An increased benchmark rate will lead to an increase in the prime rate. This is the rate on credit that banks offer their most creditworthy clients. It is upon this rate that other types of consumer credit are determined. Therefore, banks will generally increase variable rate and fixed borrowing costs. The increased prime rate will lead to an increase in credit-deposit and money market rates boosting savings by consumers and companies. This will, however, be kept in check by the preference to use savings to offset debt in order to avoid the effects of increasing variable rates.
• Impact on the national debt. A rise in interest rates will result in an increase in the cost of borrowing for the government and lead to an increase in national debt. A report by the Congressional budget office estimates that the government may pay an extra $2.9 trillion in the next decade as a result of increased interest rates (“An Update To The Budget And Economic Outlook: 2015 To 2025 | Congressional Budget Office”).
• Impact on business profits. Increased interest rates result in profits for the banking sector but reduces profits for other sectors due to the increased cost of capital needed for expansion.
• Impact on consumer spending. High credit card rates with higher rates on savings discourage consumer spending. Higher interest rates and inflation also reduce the demand in the housing sector.
Relation to macroeconomics
The Federal Reserve benchmark rate has a relation to the prevailing inflation in the country. Inflation is the rate at which the prices of various goods and services rise. As interest rates rise, consumers prefer to increase their savings in order to capitalize on higher returns. This results in reduced disposable income and therefore less spending and the economy responds by slowing down, and inflation decreases.
President Trump has raised the issue with the rate at which the Federal Reserve is increasing interest rates. His main concern is that increasing interest rates will increase the government’s cost of borrowing and slow economic growth. This is significant because the president’s main focus is on interventions that stimulate economic growth.
The current economic growth and falling unemployment being experienced will lead to increased disposable income and therefore increase consumer spending resulting in increased inflation. The Federal Reserve has an obligation to develop a growth monetary policy that keeps inflation in check (Ireland 417). As a result, the article is significant in highlighting the Federal Reserve’s dilemma and how its handling of this dilemma affects the economy.
- “An Update To The Budget And Economic Outlook: 2015 To 2025 | Congressional Budget Office”. Cbo.Gov, 2018, https://www.cbo.gov/publication/50724#section4. Accessed 16 Nov 2018.
- Ireland, Peter N. “Interest Rates, Inflation, And Federal Reserve Policy Since 1980”.
- Journal of Money, Credit And Banking, vol 32, no. 3, 2000, p. 417. JSTOR, doi:10.2307/2601173. Accessed 16 Nov 2018.