The U.S. Federal Reserve’s decision to finally start normalising interest rates, by raising the fed funds rate by one quarter of a percentage point, has emphatically ended the uncertainty over the direction the world’s largest economy is headed in. Seven years after the Fed embarked on its record monetary expansion — by beginning a programme of bond purchases and cutting itsbenchmark rate to near zero — to provide a stimulus in the wake of the 2008 financial crisis, the U.S. central bank has signalled that the American economy has definitely turned the corner. Fed chair Janet Yellen’s categorical assertion that the decision “reflects our confidence in the U.S. economy” and that the Federal Open Market Committee (FOMC) sees the economy on a path of sustainable improvement, should give comfort to investors worldwide that a key engine of the global economy is now ticking. Simultaneously, the Fed held forth the reassurance that its stance remains accommodative to support the recovery and help return inflation to the targeted level of 2 per cent. The widely anticipated decision should now infuse some much-needed optimism across both developed and emerging markets, especially at a time when global trade is stagnant and commodity prices continue to remain depressed as demand from China’s slowing economy stays muted. If history is any guide, previous tightening cycles from the Fed both in 1999 and in 2004 were coterminous with increased capital flows into emerging markets as economic growth in the U.S. spurred demand for goods and services in the developing and exporting nations. But conditions, as some economists point out, are different this time, with the majority of emerging market currencies more expensive than they were 11 years ago on an inflation-adjusted, trade-weighted basis. The immediate reaction in India’s markets was positive on Thursday as both stocks and the rupee ended stronger. And with adequate foreign exchange reserves accumulated as a bulwark against any sudden, sharp capital outflows, the Reserve Bank of India and Governor Raghuram Rajan — who had been calling for a gradual end to global easy money — appear well-prepared to deal with any exigencies, should they arise.
That the road ahead could still be anything but smooth and straight for both the global economy and the emerging markets is also amply evident in the language contained in the Fed’s communication. The FOMC statement made it clear that “economic conditions will evolve in a manner that will warrant only gradual increases” in the benchmark rate. This is shorthand for saying that interest rates are likely to inch up and over a longer duration rather than mount a well-spaced and clearly graded timetable of staircase steps. With China’s surprise yuan devaluation of August and the resultant turmoil still fresh in memory, Chinese policymakers, along with the monetary authorities in Japan, the United Kingdom and the European Union, would be closely tracked. For Indian companies, new overseas loans are likely to start getting costlier, and the appreciation of the dollar could roil corporate balance sheets as debt-servicing gets more expensive.
1 What is meant by fed fund rates?
2. Why is this in the news?
3. What is the 2008 Economic Crisis?
4. How is 2008 economic crisis linked to fed fund rates?
5. Why has the fund rate been increased?
6. Is this increase going to impact India? If yes then how?
7. The article talks about an inflation rate of 2%. What do you understand by this?
8. What is the current inflation rate prevailing in India?
9. How is inflation measured in India?
10. Which agency is responsible for determining inflation rates in India? What are various indices to measure inflation?