What is  Federal Reserve /Federal funds rate its impact on  Global Economy?

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May 2, 2024

What is  Federal Reserve /Federal funds rate its impact on  Global Economy?

Why in News? The  US Fed has recently reduced the interest rate to tackle the inflation and boost economic growth.

 About  US Fed:

  • Like other central banks such as the RBI, as the US Fed conducts monetary policy, it influences employment and inflation primarily by using policy tools to control the availability and cost of credit in the economy.
  • The Fed’s primary tool of monetary policy is the federal funds rate, changes in which influence other interest rates — which in turn influence borrowing costs for households and businesses, as well as broader financial conditions.


What will its impact in USA?

  • When interest rates go down in an economy, it becomes cheaper to borrow; so households are more inclined to buy more goods and services, and businesses have an incentive to borrow funds to expand operations, buy equipment or to invest in new projects.
  • Improved demand for goods and services ends up pushing up wages, and helps rekindle the growth cycle. Even though the linkages of monetary policy to inflation and employment are not direct or immediate, monetary policy is a key factor in curbing runaway prices or stoking the growth impetus.

What will be the impact on other markets, including India?

  • Theoretically, a signal to cut policy rates in the US should be a positive for emerging market economies, especially from a debt market perspective. Emerging economies such as India tend to have higher inflation and, therefore, higher interest rates than in developed countries.
  • As a result, investors, including Foreign Portfolio Investors, tend to borrow in the US at lower interest rates in dollar terms, and invest that money in the bonds of countries such as India in rupee terms to earn a higher rate of interest.
  • A cut in rates in the US could have a three-pronged impact. When the Fed cuts its policy rates, the difference between the interest rates of the two countries could widen, thus making countries such as India more attractive for the currency carry trade. The lower the rate in the US, the higher the arbitrage opportunity, till the time that the rate cut cycle starts in other economies as well.

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What is Federal Reserve /Federal funds rate its impact on Global Economy? | Vaid ICS Institute