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Federal Reserve chair Jerome Powell (Bloomberg file)
Federal Reserve chair Jerome Powell (Bloomberg file)

Opinion | The Fed mustn’t feed a bubble

  • The US Federal Reserve has lowered its policy interest rate by a quarter percentage point, the first rate cut since 2008

The US Federal Reserve has lowered its policy interest rate by a quarter percentage point. The rate cut, the first since 2008, was expected. US inflation is weak and America’s central bank aims to keep the American economy in expansion mode in the face of trade tensions and a global downturn. The Fed Chairman Jerome Powell, however, made it clear that the rate reduction is only a mid-cycle policy adjustment and does not herald a lengthy easing cycle. This is because the US labour market remains strong and economic activity is still rising at a moderate pace.

US President Donald Trump and some market players, who wanted a bigger cut, may be displeased, but they need to bear the risks of excessive easing in mind. Massive amounts of cheap money sloshing around the world in search of higher returns could end up inflating asset prices, as has happened in the past. If a bubble develops, a big burst could possibly wreak havoc—as seen in the first decade of this century. The unconventional easing methods that have been used by central banks to combat the West’s Great Recession of 2008-09 might have resulted in similar risks. That a significant fraction of bonds in the world are actually trading at negative yields is a worrisome sign. Whether or not there’s global trouble ahead, caution needs to be exercised.

Granted that Indian asset markets are currently in a slump, but an inward gush of funds could push the rupee upwards and thus complicate the monetary policy of the Reserve Bank, which may have to choose between a bloated rupee (which would hurt exports) and higher domestic rates of interest (if it opts to stabilize the currency and sterilize foreign exchange inflows by selling securities in the open market). Policymakers must keep a close watch of what the Fed’s move might bring in its wake.

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