Question

In 2018, the Federal Reserve, the Central Bank for the U.S., raised the Federal Funds Rate three times from 1.0% in 2017 to 2.20% in November of 2018. The Fed is likely to continue increasing interest rates in 2019 and 2020. (1) What effect is a higher Federal Funds Rate likely to have on the number of loans banks make, on consumption and on investment? Explain why. (2) Why is the Fed raising interest rates now? Explain how the current rate of unemployment, economic growth, and inflation is influencing the Fed’s decision to raise the Federal Funds Rate. (3) Why is Trump unhappy with the Fed’s decision to raise interest rates and do you agree with him?

Answer 1

1.

A higher federal fund rate, will have negative effect to the loans made by the banks, consumption and investment spending. It will happen, because a higher federal fund rate leads to the a higher discount rate and then a higher prime rate. It makes, borrowings to be more expansive for the firms as well as households. It causes, discouragement and decrease in consumption and investment spending.

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2.

Fed has a inflation rate target of 2%. But current inflation rate is 2.1%. In this regard, Fed will increase the federal fund rate so that inflation remains within the target. Further, economic growth rate is over 2% and the unemployment rate is 3.9%. These macroeconomic data shows that economy is progressing well and it needs to grow on its own. So, now Fed is willing to withdraw some of its support and let the economy function on its own. To do this and achieve, macroeconomic targets, the Fed is raising the federal fund rate.

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3.

Trump is unhappy, because Fed's policies discourage consumption and investment spending. It will cause aggregate demand to decrease and growth rate will be bit slower. It will put, Trump's government in grey that it is the government whose policy is slowing down the economic growth in the USA. Hence, people may put the government in negative. It makes Trump to be unhappy.

I do not agree with Trump's view, as Fed's decision is independent and economy should come out of those initiatives that were taken during recession after 2008. So, Fed is doing the right thing and Trump should also not be worried about it.