Explained: Fed Reserve rate hike, US recession and impact on India | Explained News,The Indian Express
The US economy is facing a curious situation. On the one hand, it is experiencing a four-decade high inflation rate and, on the other, its unemployment rate is at five-decade low.
In its continuing bid to cool down raging inflation in the United States — at 9.1% in June, the inflation rate is at a four-decade high — the Federal Reserve or Fed (US’ central bank) decided to raise the Federal Funds Rate target by another 75 basis points on Wednesday. Since March, the Fed has steadily pushed up the targeted FFR from zero to almost 2.5% now.
The FFR is the interest rate at which commercial banks in the US borrow from each other overnight. The US Fed can’t directly specify the FFR but it tries to “target” the rate by controlling the money supply. As such, when the Fed wants to raise the prevailing interest rates in the US economy, it reduces the money supply, thus forcing every lender in the economy to charge higher interest rates. The process starts with commercial banks charging higher to lend to each other for overnight loans.
This is called monetary tightening, and the Fed (or any other central bank, for that matter) resorts to it when it wants to rein in inflation in the economy. By decreasing the amount of money, as well as raising its price (the interest rate), the Fed hopes to dent the overall demand in the economy. Reduced demand for goods and services is expected to bring down inflation.
Aggressive monetary tightening — like the one currently underway in the US — involves large increases in the interest rates in a relatively short period of time, and it runs the risk of creating a recession. This is called a hard-landing of the economy as against a soft landing (which essentially refers to monetary tightening not leading to a recession). The chances of a soft-landing for the US exist but are extremely low.
The most common definition of recession requires the GDP of a country to contract in two successive quarters. Contracting GDP typically results in job losses, reduced incomes, and reduced consumption.
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