Declining Fed funds rate : any understanding of this decision to the global effects

A first in eleven years. On Wednesday, the u.s. central bank (the Federal Reserve, or Fed) has announced a reduction of its interest rates, of the order of 0.25

Declining Fed funds rate : any understanding of this decision to the global effects

A first in eleven years. On Wednesday, the u.s. central bank (the Federal Reserve, or Fed) has announced a reduction of its interest rates, of the order of 0.25 percentage points, which brings them back under 2.25 per cent . A decision with heavy consequences, but that is hard to understand. Le Figaro shows you how this announcement may upset the global economy.

" READ ALSO - Usa: first rate cut since 2008

● That means a lower interest rate?

The Federal Reserve may act on the "funds rate", that is to say, the interest rate that banks charge to lend money on the federal funds market day-to-day. "It is a basic cost, all other rates are set by comparison with him," says the head of research Fixed income at societe generale CIB, Guy Stear. These rates are fundamental, so-called "director", because they influence the market as a whole when they are modified.

● How is decided on the decline?

The Fed's decision is taken within the framework of the Federal Open Market Committee (FOMC). This structure meets eight times per year. It "examines the economic and financial conditions, determines the proper orientation of monetary policy and assesses the risks to its long-term objectives". Simply put, the FOMC is responsible for monetary policy of the United States, and gives the tone in matters of interest rate. It is composed of twelve members, including seven members of the board of governors of the Fed, the president of the Federal Reserve Bank of New York, and four presidents of the other Reserve Banks in the us.

In its mission, the Fed is charged by Congress to set monetary policy with completing three objectives: to ensure maximum employment, stable prices and interest rates long-term moderate. The FOMC participates in the accomplishment of these objectives: if people can borrow and consume, this creates the conditions for a price increase. In this, the interest rates have a direct effect on inflation. In January 2012, the committee stated that a 2% inflation "would be the best fit long-term of the mandate" of the Fed, because it is a middle to eat while avoiding deflation.

● What are the expected effects?

When the economy slows, the Fed may be tempted to lower its key interest rates, which pushes the different economic actors to borrow to invest and consume, favoring the growth. "If the rate is lower, the cost of the money, that is to say the amount that he will repay in fine , will be less important", explains Nicolas Goetzmann, head of the research and of the economic strategy in the Financial life of the city. "The cost of money down, which encourages individuals and companies to borrow, invest and spend," says Guy Stear. Conversely, "if the economy is operating at full capacity, the Fed can raise rates to avoid overheating of the system," continues Nicolas Goetzmann.

Concretely, at the conclusion of the FOMC meeting, the Fed released a statement in which it explains its decisions regarding the interest rate. Behind, the president of the institution, Jerome Powell, holds a press conference highly anticipated, in which he explains the Fed's decision, and talks about the situation of the american economy. "Even more than the announcement of the rate, this is the comment behind that is important, analysis Guy Stear. It allows you to see if it is, for the Fed, the beginning of a long period of falling interest rates, or if it is waiting to see how will evolve the american economy in the coming months".

● what has happened to the rate in recent years?

A decline in the reference interest rate is rare, and means that the economy faces difficulties. In December 2008, the Fed lowered its rates in a range of 0% to 0.25%, explaining this by "challenging economic conditions", the "lower inflation" and the lower "consumer spending, business investment and industrial production". At the time, the institution had on this decrease to counteract the financial crisis that hit the United States.

The rate remained at this level for nearly seven years. In march 2015, after several difficult years, noting that "the risks which weigh on the business outlook and the labour market" were significantly reduced, the FOMC warned that the rates would again increase over the medium term. The time of "free money" was coming to an end, with "a balanced approach", smooth. From December 2015, the rates have gradually increased, reaching a range of 1.25% to 1.50% in December 2017 and 2.25% to 2.50% a year later.

" frameborder="0" scrolling="no" style="border:0;"> They have increased continuously since, except in 2019, where they have stagnated. This time, the Fed has announced a reduction of a quarter of a percentage point in interest rates, reversing the dynamic that is visible from 2015. And this, despite the dynamic composition of the u.s. economy. It is on this contradiction that the explanation of Jerome Powell is expected.

● Why is this so important to Donald Trump?

The president of the United States as a result of rising interest rates a casus belli . Donald Trump is back regularly on this subject, explaining that these increases were "a mistake" that would penalize the u.s. economy over the long term. "The Fed has "lifted" [rates] too soon and too much. [...] So that our country is doing very well, the potential creation of wealth that has been missed, in particular with respect to our debt, is staggering", regretted it as well on Twitter a few days ago. For the occupant of the oval Office, it is better to a strong decline in interest rates that pushes the Americans to spend, even if you make increase the debt. A logic which includes, in particular, when we know that the United States is in the midst of elections, and that the economic argument is the flagship of Donald Trump.

on Tuesday, the president said that he wanted to "see a sharp decline" rates, much more massive than 0.25 percentage point expected. "If the Fed had done its job well, what it has not done so", the Exchange, growth and the labour market, americans would be better off, consider Donald Trump, who has repeatedly criticized the decisions of Jerome Powell. "Obama had zero interest rate, we have interest rate standardized", he complained this week.

To Nicolas Goetzmann, the planned reduction of 0.25 percentage point will be consider as insufficient by Donald Trump. "The economy american relies heavily on its domestic demand, more so than in Europe. So he wants to compensate for the effects of its trade war with China by supporting the national event," says-t it.

● is there a "war of rates"?

This is one of the arguments of Donald Trump: "we are competing with countries that play against the United States. This is why the european Union was formed... And for China, up to now, the United States has been a target of choice", he stood in line. According to him, the u.s. economy cannot prevail in the face of competitors - Beijing and the Old continent - that keep, them, cheap rates. If the european companies and consumers can borrow money at a low cost, this is not the case of the Americans, he argues. A policy of low rates that he describes as "very unfair for the United States."

" READ ALSO - The Fed resists the Trump and refuses to lower its key interest rate

To Guy Stear, "Donald Trump think rates are too high compared to other countries. For him, the dollar is too strong compared to other currencies, which, in his opinion, is hampering the exports of american companies". For his part, Nicolas Goetzmann believes that the reasoning of the occupant of the oval Office lack of perspective: "if China and the european Union lowered their rates, and are in a currency war, everyone supports its domestic economy, which benefits the whole world," giving a boost to demand.

The european central Bank announced last week that it was necessary to maintain "a very aggressively accommodative stance of monetary policy over an extended period of time". The rates will remain "at current levels, or at lower levels, at least during the first half of 2020," announced the institution headed by Mario Draghi.

● Lower rates, is this a good thing?

This question is more tricky than it seems. Lower interest rates can reduce the cost of debt for the States, enterprises and households, improving the consumption, investment and strengthens the economy. "Conjoncturellement, the trade war between Beijing and Washington may start with having a negative effect on the economy as on the level of investment of american companies, worried for the future," explains Nicolas Goetzmann. Lower rates could limit the slowdown.

The Fed is surprised also that the price does not wish to climb, while the u.s. unemployment, at 3.6%, is supposed to have reached its structural level. In these conditions, to accompany the growth to continue to reduce unemployment could trigger inflation, allowing the institution to fulfill its mission. "Lowering the rate today will increase in the longer term", adds the expert.

" READ ALSO - The us economy fails, always not

However, this policy remains contested. First, the low interest rates cut into the profitability of the banks, who make less money by lending to their debtors. "The banks make less money by lending, but they also pay less in borrowing", nuance, however, Guy Stear. Then, the actual effect of a policy of low interest rate on consumption remains to be shown: "the interest rate cuts in the short-term are less effective to stimulate the growth of bank credit, where the rates reach a very low level", concluded a study for the Bank of international regulations in February 2017. In the Face of declining margins, banks may decide, for example, to reduce the flow of loans to minimize losses. There is also no indication that economic actors, worried about the future, do note not savings, rather than consumption.

Also, the low-rate growth driven by the loan, debt and credit. An unstable base, which allows the economic actors to be vulnerable to rising interest rates. "Everything depends on the reason for which companies borrow. They can create dividends that are most important for the shareholders, or establish factories on american soil and jobs," believes the expert of Société générale CIB.

A lower rate, is not unanimous. In particular, it is contested by the chairman of the u.s. federal Reserve of Boston, Eric Rosengren, who did not wish to discount "if the economy goes perfectly well without this "boost". Same sound of bell on the side of Esther George, of the antenna of the Fed in Kansas City: "I don't see an argument in favour of a rate cut for now", she said in may. A rate cut is, however, supported by the former president of the Fed, Janet Yellen, the same one which had raised rates for the first time in 2015...

Date Of Update: 01 Ağustos 2019, 00:00

Kathleen Lees


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