Why in the News?

The United States Federal Reserve, responsible for the country’s monetary policy, announced on Wednesday that it will lower its key interest rate, called the Federal Funds Rate, by 0.5%, or 50 basis points.

Why did the Fed cut interest rates?

• The Federal Reserve cut the benchmark interest rate by 50 basis points to address rising unemployment concerns while inflation was stabilizing.
• After a series of aggressive rate hikes to counter inflation that surged due to post-COVID recovery and the Russia-Ukraine war, inflation began to moderate, nearing the Fed’s target of 2%.
• Rising unemployment data signaled that the restrictive monetary policy might harm the labor market, prompting the Fed to act.

Will the US economy achieve a soft landing?

• Optimistic Projections: Despite earlier predictions that high inflation would lead to a recession, the Fed’s strategy may succeed in achieving a soft landing, reducing inflation without crashing the economy.
• GDP Growth: The Summary of Economic Projections (SEP) estimates GDP growth to remain around 2% for the next few years, indicating a stable economy.
• Unemployment: While the unemployment rate has risen slightly to 4.4%, it remains manageable, with expectations of improvement.
• Risks: Potential policy shifts, especially related to the upcoming presidential election, could disrupt the economic outlook, particularly if trade tariffs are imposed.

How will India be affected?

• Increased Foreign Investments: Lower US interest rates could encourage foreign investors to borrow in the US and invest in India through stocks, bonds, or foreign direct investment (FDI), benefiting capital inflow.
• Rupee Strengthening: With falling US interest rates, the US dollar may weaken against the Indian rupee, potentially strengthening the rupee. This would negatively affect Indian exporters but benefit importers.
• RBI’s Interest Rate Decisions: While the Fed’s rate cuts influence global markets, India’s central bank, the RBI, may not directly follow suit due to differing inflation targets and mandates. The RBI prioritizes inflation control and GDP growth over unemployment figures.

Way forward: 

• Encourage Capital Inflows: India should take advantage of lower US interest rates by attracting foreign investments through improved ease of doing business, fostering growth in key sectors like infrastructure, technology, and manufacturing.
• Maintain Monetary Stability: The RBI should carefully assess global trends but prioritize domestic conditions when adjusting interest rates, focusing on inflation control, financial stability, and sustained GDP growth.

Mains PYQ:

Q Do you agree with the view that steady GDP growth and low inflation have left the Indian economy in good shape? Give reasons in support of your arguments. (UPSC IAS/2016)

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