Federal Reserve October Decision and inflation!
Yesterday, Mr. Jerome powell has announced interest rate cuts, The Fed cut its Fed funds target rate 25 base points to 1.50% to 1.75%, and gave its point of view about the US economy and expectations, so what is the role of the federal reserve, why this decision has been made, why inflation is main issue to Fed?
The Federal Reserve was founded in 1913, and it is the central bank of the US, the general role of this bank is to monitor and do any adjustment needed to the US economy, but how does this bank do that? The Federal Reserve has many tools to adopt, a main tool is frequently used by the Federal Reserve is monetary policy, by which the Federal reserve sets the borrowing cost in the market, which will is control the amount of money in the market depending on the economy status.
As mentioned, the Federal Reserve has announced rate cut yesterday, and this was the third cut in 2019. The Federal Reserve rationalized this cut with weak fixed business investment and weak exports.
This time, the interest rates cut was not because there is something wrong in the economy, but it is about the uncertainty raising out there, in addition to keep around 2% inflation rates.
The symmetric 2% inflation rate as the fed call was set in 1995, and since then the fed is trying all the time to be as near as possible to this number. But what is happening since the 2008 crisis, and despite the continuous steady economic growth the inflation rate doesn’t reach the 2% target.
Economists suggested many reasons behind low inflation rates, some of them has attributed this to the technology advancement, and how does this advancement has increased the machine productivity, which suppressed unit labor costs, other economists went more further by connecting these low numbers of inflation to demographic transitions and tried to draw a pattern through having a look on the Japanese experience of low inflation, which was explained by some economist by the old age population.
A low inflation is good for healthy economy, but not too low inflation or negative inflation (deflation) which is usually associated with weak economic conditions. The 2% target inflation rate gives the monetary policy makers an indication that the inflation is under control, and the economy is performing good enough, in addition to keep a safe area away of deflation.
No one likes inflation, yet it is needed in low positive numbers, and this is the second main reason that pushed the Fed to cut rates.