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Reasons, effects of keeping interest rates high

Feb 11,2024 - Last updated at Feb 11,2024

The decision of the US Federal Reserve to keep interest rates unchanged at their elevated levels (5.25 per cent-5.50 per cent) has compelling economic justifications.

Firstly, the Fed remains concerned that the achieved decreases in inflation levels are not assured, primarily due to recent political, security and economic developments (ongoing war in Ukraine, outbreak of war in Gaza and escalating disruptions in the region) which may adversely impact global price levels and potentially drive prices higher again.

Secondly, the Fed's tight monetary policy since March 2022 has not resulted in economic slowdown or increased unemployment rates in the United States, as official data indicates. Unemployment rates in December 2023 reached only 3.7 per cent, aligning with full employment levels according to economic theory. The Federal Reserve bases its monetary decisions on data-driven analysis. Jerome Powell affirmed that there will be no interest rate cuts in March, implying that interest rates will remain high throughout the first quarter of the current year. This aligns with the expectations of Christine Lagarde, president of the European Central Bank, who stated, in Davos's meetings, that interest rate cuts would begin in the coming summer. Following this, the Bank of England decided to maintain interest rates at their current high levels.

It is evident that central banks worldwide typically await the decisions of the US Federal Reserve and its interpretation of the global economic landscape before announcing their own monetary policies, which often mirror those of the Federal Reserve. This indicates that the Federal Reserve remains the most influential player in global markets.

Moreover, there are several reasons encouraging the Federal Reserve to keep interest rates at historically high levels:

Current inflation rates in the United States (3.4 per cent) have not yet reached their targeted levels (2 per cent). Additionally, there are concerns at the Fed regarding uncertain expectations of increased inflation due to global crises and events. Therefore, the Fed chose to keep interest rates high to mitigate demand and combat inflation, ensuring that the decrease in inflation rates is genuine and stable.

High interest rates make saving more attractive to investors and savers, reducing consumption demand and providing support for sustainable growth.

The Federal Reserve's decision to maintain high interest rates helps achieve economic growth balance, maintaining market stability and avoiding economic bubbles. High interest rates increase the cost of borrowing for speculative purposes, reducing financial activity reliant on borrowing for purchasing investment assets. This can reduce unjustified speculation and potential market bubbles, leading to better reflection of prices based on real economic fundamentals, reducing the likelihood of market bubbles.

Keeping interest rates high means higher borrowing costs, reducing personal and government debt, thus reducing the risks of public debt escalation.

High interest rates strengthen the value of the US dollar against other currencies, improving trade balance and enhancing global monetary stability.

Given the significant contribution and impact of the US economy on the global economy, high interest rate policies in the United States may contribute to reducing global inflation and achieving global economic stability.

Among the notable consequences of keeping interest rates high on financial and economic markets, we mention the following:

Impact on financial markets: Due to the increased cost of borrowing, demand for investment in stocks and bonds may decline, leading to price decreases.

Impact on the real estate market: High interest rates may directly affect the real estate market, as mortgage financing becomes more costly, reducing purchasing power for buyers and decreasing demand for properties, resulting in slowing growth in the real estate market.

Impact on economic growth: High interest rates can negatively affect economic growth by increasing borrowing costs for companies and individuals, reducing spending and investment, thus reducing overall economic growth.

Impact on gold and oil markets: The effect of high interest rates can also be reflected in the prices of commodities such as gold and oil. Due to the high cost of borrowing, demand for these commodities as investment assets may decrease, leading to price declines. This was directly observed after the Federal Reserve announced its decision to keep interest rates at historically high levels.

Impact on currency markets: It is expected that the increase in interest rates will strengthen traditional currencies against digital currencies. Higher interest rates increase the benefits of investing in traditional currencies, thereby reducing the attractiveness of digital currencies.

In general, the Federal Reserve makes its interest rate decisions based on a comprehensive assessment of domestic and global economic conditions, focusing on achieving long-term economic and financial stability.

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