Hawkish Economic Policy

Disclaimer: Copyright infringement not intended.

Context

• As the US approaches its presidential election in November, the Federal Reserve, the country’s central bank, has indicated it will not reduce interest rates quickly.
• This decision impacts not only President Joe Biden's re-election prospects but also global economies, especially emerging markets like India.

READ DETAILED ARTICLES ON US FED RATE HIKES:

https://www.iasgyan.in/daily-current-affairs/us-fed-rate-hike-46

https://www.iasgyan.in/daily-current-affairs/us-fed-rate-hike

Impact of US Federal Reserve's Actions

• Global Influence: The US is the world's largest economy, and the US dollar is the key global currency. Thus, the Federal Reserve's actions are closely watched by global policymakers.
• Currency Strength: Higher US interest rates strengthen the dollar against other currencies, causing investors to move their money from emerging markets back to the US.
• Historical Impact: Even hints of an interest rate hike can disrupt emerging economies. This was seen during the 2013 Taper Tantrum when then Fed chair Ben Bernanke’s hint at monetary tightening led to significant capital outflows from the "fragile five" economies, including India.

US vs India: Central Bank Mechanisms

• US Federal Reserve:
• Federal Funds Rate (FFR): The Fed targets the FFR, the interest rate at which commercial banks borrow from each other.
• Monetary Supply Adjustments: The Fed can influence the FFR by adjusting the overall money supply.
• Current Stance: Fed chair Jay Powell stated that it would not be appropriate to reduce the target range from 5.5% until there is more confidence that inflation is moving towards the 2% target.

• Reserve Bank of India (RBI):
• Repo Rate: The RBI directly adjusts the repo rate, the interest rate at which it lends to the banking system.
• Inflation Target: The RBI targets a 4% inflation rate, unlike the Fed's 2% target.
• Policy Similarity: Both the Fed and RBI adopt a cautious approach to avoid reversing policy too soon, which could lead to increased inflation.

Resilience of India's Economy

• Independence from the Fed: India’s economy has become more resilient to the Fed’s actions over the years. The RBI maintains its independence in rate adjustments regardless of the Fed’s decisions.
• Interest Rate Differential: Despite this resilience, the Fed’s cautious stance gives the RBI a reason to avoid cutting domestic interest rates too soon to prevent widening the interest rate gap between the two economies.

READ DETAILED ARTICLES ON US FED RATE HIKES:

https://www.iasgyan.in/daily-current-affairs/us-fed-rate-hike-46

https://www.iasgyan.in/daily-current-affairs/us-fed-rate-hike

PRACTICE QUESTION Q. Examine the impact of US Federal Reserve rate hikes on emerging economies like India. How do changes in the Federal Funds Rate affect capital flows, currency stability, and macroeconomic policies in these countries? What measures can emerging economies take to mitigate these effects?