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U.S. Federal Reserve Rate Hike UPSC NOTE

 


What is the Federal Reserve?

  • The Federal Reserve (also known as the Fed) is the central banking system of the United States, established in 1913 through the Federal Reserve Act to address financial crises and promote economic stability.

What does a pause in rate hikes mean?

  • The U.S. Federal Reserve (Fed) last week paused its rate hike cycle by deciding to hold interest rates after ten rate hikes since March 2022. 

  • The central bank kept its target for the benchmark federal funds rate between 5% and 5.25% until its next policy meeting.





  • Central banks around the world try to steer their economies primarily by targeting interest rates at which lending/borrowing happens in the short-term credit markets.

  • For instance, if a central bank wants to lower short-term interest rates, it can enter the market where banks borrow funds for their short-term needs with fresh funds, bid up the price of these loans and thus lower interest rates.

  • The fresh money injected into the banking system, in turn, would tend to percolate into the economy and cause prices to rise in the wider economy.



  • A central bank can thus use monetary policy to influence prices in the wider economy. And keeping inflation within a certain target range is a major goal of central banks.

  • Another policy goal that central banks try to meet along with the inflation target is to keep the economy operating at its full capacity wherein all resources are fully employed. 

  • Many economists believe that there is a trade-off between inflation and unemployment. 


  • According to this framework, if inflation falls too low, this can cause a rise in unemployment and hence unused capacity. 

  • So, the agenda of most central banks is to keep inflation up at a certain level at which the economy functions at full capacity. 

  • Inflation above a certain level, however, is seen as having no positive effect on economic activity.

Why did the Fed decide to hold rates steady?

  • The central bank is waiting for signs that there has been a decisive slowdown in inflation before it decides on further actions.



  • The labour market does not seem to be heavily affected by the Fed’s rate hikes since last year.

  • Moreover, the effects of monetary policy usually take time to impact prices in the wider economy.

  • So, the Fed may be cautious after a series of ten rate hikes about allowing interest rates to rise too much and too soon. 

  • A rapid withdrawal of monetary support can cause prices to undershoot the Fed’s inflation target, something the U.S. central bank may not want.


Co-relation of Federal Reserve & Indian Markets

  • A significant disparity in interest rates of the two countries could lead to currency depreciation, resulting in higher import costs and inflation for India.

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Learnerz IAS | Concept oriented UPSC Classes in Malayalam: U.S. Federal Reserve Rate Hike UPSC NOTE
U.S. Federal Reserve Rate Hike UPSC NOTE
Learnerz IAS | Concept oriented UPSC Classes in Malayalam
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