Should the Federal Reserve Raise Interest Rates?

Topic: Banking
Words: 702 Pages: 2

Observing the flow of financial news, an investor may notice that special attention is paid to information on interest rates of the central banks of various states and the US Federal Reserve. Without exception, all markets react not only to rate changes but also to expectations of its increase or decrease in the future. In simple words, the interest rate is the amount of interest paid to central banks for loans provided to banking organizations (Dery & Serletis 7). It is capable of influencing all areas of state life, from the well-being of individual households to the price of shares in huge corporations. Therefore, interest rates are among the most significant indicators of fundamental analytics. This paper aims to analyze if the Federal Reserve should raise interest rates or not.

The Federal Reserve’s interest rate is called the official discount rate. It is the most significant indicator among all central banks in the world. The change in interest rates is carried out based on two goals: to stimulate economic growth and strengthen the national currency as well as control inflation. With an increase in interest rates, the shares of most companies will experience the opposite process – a decline in value (Dery & Serletis 25). Vice versa, with a decrease in the interest rate, the value of shares will increase. Regarding the FRS rate, the rule applicable to all rates remains. When it increases, the cost of shares and bonds becomes cheaper and inflation slows down.

The ongoing health crisis will seriously affect economic activity, employment, and inflation in the short term. It will also pose significant risks to economic development around the world. The Federal Reserve stands ready to do whatever it can to support the economy hit by the coronavirus pandemic. Therefore, it has announced that it does not plan to raise interest rates until 2022 inclusive (Cox). The majority of the voting members of the US Federal Reserve Committee on open markets are in favor of keeping the interest rate at zero until the end of 2023 (Cox). This information follows from the block of macroeconomic forecasts published by the Federal Reserve this year.

Moreover, the FRS cut interest rates back in 2019 since the development of the economic situation did not meet expectations. Inflation and market interest rates are still lower than some of the central bank’s forecast models have suggested, after years of strong job and economic growth (Cox). This means that the Federal Reserve leaders have not yet provided the economy with sufficient support, although the key interest rate they have set is historically low. That is why the federal funding rate remained at the level of 0–0.25%.

Some believe that the rate should be even lower to provide additional support amid an increasingly negative outlook for the global economy, clouded by uncertainty in international trade. The Federal Reserve officials observe the strengthening of the connection between the American economy and the economies of other countries and believe that rates in the US should not be much higher than rates in other economically developed countries (Mertens & Williams 430). This signifies a change in the mindset of central bankers after raising the key rate from near-zero levels in recent years, based on models that lower unemployment should have accelerated inflation.

Fears about inflation are another reason why the Federal Reserve officials may signal the likelihood of further rate cuts this year. The President of the Federal Reserve Bank of Chicago, Charles Evans, said that the key rate should be lowered by at least half a percentage point from the current level to accelerate inflation (Mertens & Williams 428). It is also predicted that the Central Bank will have to cut the rate by half a percentage point by the end of this year.

The analysis of the evidence and current situation in the global economy has shown that the Federal Reserve should not raise interest rates. If the FRS raises interest rates, it has an extremely negative impact on the state of the budgets of the world’s largest economies and the behavior of their consumers. Therefore, the Federal Reserve has announced its readiness to keep rates at a level close to zero for a long time.

Works Cited

Cox, Jeff. “Fed Cuts Rates by Half a Percentage Point to Combat Coronavirus Slowdown.CNBC. 2020. Web.

Dery, Cosmas, and Apostolos Serletis. “Interest Rates, Money, and Economic Activity.” Macroeconomic Dynamics, 2019, 1-50.

Mertens, Thomas M., and John C. Williams. “Monetary Policy Frameworks and the Effective Lower Bound on Interest Rates.” AEA Papers and Proceedings, 109, 2019, 427-432.

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