In January of this year US equity markets were rattled by signs of a slowdown in

Question

In January of this year US equity markets were rattled by signs of a slowdown in growth of the Chinese economy and other emerging markets, collapsing prices of oil and stagnation in most of the Euro zone countries. More recently, the UK vote to withdraw from the EU (“Brexit”), rattled currency and equity markets around the world.

In response, central banks outside the US have adopted policies which reduce interest rates in their economies. In Japan, Switzerland and in the Euro zone yields on short term treasury bills and even on medium term treasury notes of 2 year to 10 year maturities have fallen to less than 0. However, continued strong growth in employment in the US together with signs of recovery in residential housing and consumer confidence have prompted a rally in US equities, with major US indices like the S&P 500 closing at or near record highs today. (July 11)

A)Given the desperate effort by major central banks to boost their economies’ growth through interest rates on sovereign debt that are below 0, what is the likely impact on the Exchange rate of the $ versus other currencies if the Fed decides to raise its Federal Funds Rate target 50 total basis points over the rest of 2016 year? (As late as this past March many members of the Fed’s open market committee thought growth momentum in the US economy was strong enough to warrant two 25 basis point increases in the Fed Funds rate target zone during the last half of 2016.) Explain your answer.   

B)Given the current condition of the US economy, do you think Fed policy makers would prefer to see the $ rise in value, decline in value or stay at its current value? Discuss the advantages and disadvantages to the US economy at this time of a stronger vs. a weaker $. Frame your answer in terms of the current Aggregate Demand and Aggregate Supply situation of the US economy.   

C)Given your answers to parts A&B of this question, do you think the probability of two rate hikes this year by the Fed has increased or diminished since March? Explain your answer.

Explanation / Answer

A) First of all we must understand that an economy the size of united states must have fiscal responsibility, You just cannot have zero intrest rates, The nominal intrest rate at zero is just irresponsible,

If you are a bank and you loan $1 billion from fed and inflation rate is 5%, Then bank effectively recieve 5% intrest from fed. Fed cant be loosing money for ever, Its public money after all.

Fed had rised intrest rates by 0.25 basis points and might rise another 0.25 in coming months is the step in right direction.

B) A strong dollar is what america needs right now, we cannot afford to have a weak dollar, US manufacturing industry is almost non-existant and we buy lot of goods and services from overseas, So as largest economy in world and engine of global growth and issuer of global reserve currency USD must be strong, but strong dollar also poses considerable problems for exporters.

C) The possibility of rate hikes has dimnished from march as US growth rate is a mere 1%. Further rate cuts or policy changes cannot be ruled out.

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