The Federal Reserve Statement on the Interest Rate

On Wednesday, the Federal Reserve made a statement to keep the interest rate low for now, which they are expected to make a move to raise its short-term interest rate in midyear. This statement is a continuation of a December meeting, where the Federal Open Market Committee (FOMC) decided to increase the interest rate this year. The interest rate has remained near zero since 2008 after the Great Recession along with an aggressive move by the Fed to use quantitative easing (QE). The Fed is in a process to normalize their monetary policy to pre-2008 level, and their first step was to end QE in 2014 as an exit strategy to their stimulus plan. Although the Fed made a statement to keep the interest rate same, it is only a matter of time before the short-term interest rate rises. Of course, the FOMC knows the effect of raising the interest rate, but it is always worth to consider the negative effects.

 

If the Fed were to raise the interest rate, how will it influence the U.S economy? As stated in Jon Hilsenrath’s article, the increase in the interest rate may put a heavy burden on U.S. exports. The increasing rate will draw investors, which will strengthen its currency. Currently, many of the major international economies, in particular Japan and the EU, are planning on aggressive bond-buying programs to boost their economy. The ECB has proposed a quantitative easing to buy a total of “60 billion Euros a month in asset including government bonds, debt securities issued by European institutions and private-sector bonds” (Wall Street Journal.) The ECB’s quantitative easing will pull down the value of euro in relative to dollar. The international trade will favor Eurozone countries while the U.S export hurts as a result of the stronger dollar. Likewise, Bank of Japan, which has been using monetary easing since 2012, will continue to maintain its depreciating currency in order to fight against deflation and increase export. Along with the increasing rate by the Fed, the QE by both ECB and Japan may amplify the negative impact on the export sector. While many of the banks are “easing monetary conditions to combat their own problems with low inflation and slow growth,” the divergence between the “Fed and other central banks could unsettle markets and further complicates the U.S. central bank’s calculus” (The Wall Street Journal).

 

So when is the right time for the Fed to normalize the stance of monetary policy by raising the interest rate? The U.S economy is “expanding at a solid pace and job gains are strong…however, the central bank hinted at wariness about low inflation, slow global growth, a stronger U.S. dollar and international market turbulence” (The Wall Street Journal). Because the economy has just turned to stability, I believe the Fed should wait and see how U.S economy reacts to the global economy changes. There is nothing much that the Fed can react to the ECB’s QE and drop in crude oil price. Certainly, the Fed will not push back against the ECB to stabilize the export by initiating QE to lower their value of currency. So it may be an option to stall the interest rate in the current level until the end of the year after the economy is fully reflected by the international influence. As Mr. Grapen, a chief U.S economist at Bay Capital, said “market are really looking at a stronger dollar and having a hard time seeing the Fed being ready to go in June” (The Wall Street Journal).

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