U.S. Fed raises rate by 75 bps to tame inflation – INSIGHTSIAS

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Syllabus: Basic Economics

 

Context:

The US Federal Reserve announced the most aggressive interest rate increase in almost 30 years, raising the benchmark borrowing rate by 0.75 percentage points.

 

Basics: Increasing interest rate will make US bonds more attractive and investors/citizens will invest in them rather than spend. Also, borrowings will become costly, this will rein in inflation. Also, FII from emerging markets may take out their money and invest in US bonds. This will strengthen the US currency against others.

 

Impact on India: It could have a three-pronged impact on India.

  1. When the Fed raises its policy rates, the difference between the interest rates of the two countries narrows, thus, making countries such as India less attractive for the currency carry trade.
  2. Higher returns in the US debt markets may also lead to the flight of foreign investors from India
  3. It could weaken the Indian currency vis a vis US Dollars.

 

Q6 .With reference to the Indian economy, consider the following statements: (UPSC CSE 2022)

  1. If the inflation is too high, Reserve Bank of India (RBI) is likely to buy government securities.
  2. If the rupee is rapidly depreciating, RBI is likely to sell dollars in the market.
  3. If interest rates in the USA or European Union were to fall, that is likely to induce RBI to buy dollars.

Which of the statements given below is/are correct?

  1. 1 and 2 only
  2. 2 and 3 only
  3. 1 and 3 only
  4. 1, 2 and 3

Answer: (b)

Justification:

Statement 1 is incorrect: To control inflation, the RBI sells the securities in the money market which sucks out excess liquidity from the market. As the amount of liquid cash decreases, demand goes down. This part of monetary policy is called the open market operation.

Statement 2 is correct: If the rupee is depreciating, RBI pumps the dollar into the market, this results in an increase in foreign currency supply and a decrease in Rupee supply, thus appreciating its value.

Statement 3 is correct: If interest rates in US and EU fall, investors would like to park more money in emerging market such as India for better returns, thus Indian market would be flooded with foreign currency. To stabilize it, RBI would likely buy excess dollars.

 

Q7.Which among the following steps is most likely to be taken at the time of an economic recession? (UPSC CSE 2021)

  1. Cut in tax rates accompanied by increase in interest rate.
  2. Increase in expenditure on public projects.
  3. Increase in tax rates accompanied by reduction of interest rate.
  4. Reduction of expenditure on public projects.

Answer: b

 

 Q8. If the interest rate is decreased in an economy, it will (UPSC CSE 2014)

(a) decrease the consumption expenditure in the economy

(b) increase the tax collection of the Government

(c) increase the investment expenditure in the economy

(d) increase the total savings in the economy

Answer: C

In the interest rate is decreased, it becomes easier to borrow money at a low-interest rate and therefore individuals/companies will increase their investment expenditure.

Source: Indian express

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