The US Federal Reserve, commonly referred to as the Fed, is the central banking system of the United States established in 1913 to promote economic stability and address financial crises. The Fed comprises a Board of Governors in Washington, D.C., and 12 regional Federal Reserve Banks located in major cities throughout the country. The primary responsibilities of the Fed include conducting monetary policy to promote price stability and full employment, supervising and regulating banks and other financial institutions, and providing financial services to the US government and other banks.

US Fed Interest Rate Hike Impact

Recently, in March 2023, the US Federal Reserve raised interest rates by a quarter of a percentage point. The impact of this rate hike on various entities is significant and deserves attention.

Impact on Asset Prices

An immediate effect of an increase in interest rates is the discounting of asset prices at a higher rate. When interest rates rise, investors demand higher rates of return on their assets, causing prices to drop. Even U.S. Treasury securities, considered the safest assets globally, are not immune to interest rate increases. Investors holding U.S. 10-year and 30-year Treasury securities face significant unrealized losses due to rising interest rates.

Impact on Banks

The decline in asset prices has resulted in the collapse of Silicon Valley Bank and Signature Bank. SVB had 55% of its assets in securities and was facing an unrealized loss of over $18 billion, leading to severe trouble and risking collapse. This situation highlights the importance of considering unlikely scenarios that could wipe out holdings, even in safe assets like U.S. Treasury securities.

Impact on India

To mitigate spillover effects, the Reserve Bank of India (RBI) must increase interest rates in line with the Federal Reserve. A significant disparity in interest rates could lead to currency depreciation, resulting in higher import costs and inflation. India must address its inflation problem by raising interest rates, regardless of the Federal Reserve’s actions. Banks must increase their lending rates to maintain their net interest margin in line with the RBI. In keeping with the RBI’s policy, the State Bank of India has raised its housing loan rate to 8.5% as of March 2023 from a low of 6.75% in 2021.

Impact on Borrowers

The rise in interest rates implies that people with EMIs may find it challenging to maintain their standard of living, as it indicates wage cuts and possible job losses. Loans and EMIs alone do not guarantee a better quality of life for salaried individuals. To manage financial difficulties, it is essential to live within one’s means, build a nest egg by investing in the stock market, and pay off EMIs without incurring further debt.

Positive Real Rates and Inflation

According to some economists, positive real rates are necessary to effectively address inflation. Despite a steady decline in inflation rates from 9% to 6% in the past year, persistent inflation highlights that the Federal Reserve needs to take further measures to increase rates.

Why In News

The Federal Reserve of the US, also known as the Fed, is the country’s central bank responsible for setting monetary policy and regulating the nation’s financial institutions. Its decisions, such as the interest rate hike in March 2023, can have far-reaching effects on the economy and individual consumers, businesses, and investors alike. It is important to stay informed and understand how these decisions may impact your financial situation.

MCQs on US Federal Reserve Interest Rate Hike

  1. What is the impact of an increase in interest rates on asset prices?
    A. It increases asset prices
    B. It has no impact on asset prices
    C. It decreases asset prices
    D. It stabilizes asset prices
    Correct Answer: C. It decreases asset prices
    Explanation: An increase in interest rates causes investors to demand higher returns on their assets, leading to a decrease in asset prices.
  2. What is the impact of the US Federal Reserve’s interest rate hike on borrowers?
    A. It makes it easier for borrowers to maintain their standard of living
    B. It has no impact on borrowers
    C. It makes it challenging for borrowers to maintain their standard of living
    D. It reduces the interest rates for borrowers
    Correct Answer: C. It makes it challenging for borrowers to maintain their standard of living
    Explanation: An increase in interest rates implies that people with EMIs may find it challenging to maintain their standard of living, as it indicates wage cuts and possible job losses.
  3. Why does the Reserve Bank of India (RBI) need to increase interest rates in line with the Federal Reserve’s actions?
    A. To reduce currency depreciation
    B. To maintain the net interest margin
    C. To address India’s inflation problem
    D. To mitigate spillover effects
    Correct Answer: D. To mitigate spillover effects
    Explanation: To mitigate spillover effects, the Reserve Bank of India (RBI) must increase interest rates in line with the Federal Reserve. A significant disparity in interest rates could lead to currency depreciation, resulting in higher import costs and inflation.
  4. What is the primary responsibility of the Fed?
    A. Conducting monetary policy
    B. Regulating the stock market
    C. Providing loans to individuals
    D. Promoting international trade
    Correct Answer: A. Conducting monetary policy
    Explanation: As mentioned in the essay, the primary responsibilities of the Fed include conducting monetary policy to promote price stability and full employment, supervising and regulating banks and other financial institutions, and providing financial services to the US government and other banks.

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