ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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A Rate Cut That Failed to Please

The decision of the United States Federal Reserve to cut short its cycle of interest rate increases and reduce rates, while announcing a halt to its quantitative tightening programme, is likely to restore an environment of excess and cheap liquidity. While justified as a means to strengthen the US recovery, this move would in all probability deliver increased financial speculation rather than higher growth. If that triggers another financial boom–bust cycle, slow growth could be followed by another deep recession.

On 31 July, the United States Federal Reserve System (US Fed) announced its decision to cut its benchmark short-term interest rate by one quarter of a percentage point to a target range between 2% and 2.25%. It also announced that it would put an end to its policy of selling chunks of its holdings of securities, so as to unwind its bloated balance sheet. The rate cut was indeed the first in a decade, as the global financial media reported. But, that was not why the reduction was newsworthy. It was because with the cut the Fed was, rather early, turning its back to the effort that had been on since early 2016 to move interest rates back to pre-crisis levels and undo the policy of quantitative easing (QE).

Starting 2016, gradual rate increases and asset sales by the Fed were presented as necessary, because “unconventional monetary policies” adopted to combat the recession precipitated by the global financial crisis (GFC) had been in place for too long. Interest rates had been at near-zero levels for eight years and the policy of QE, or injection of liquidity through purchase of securities, had led to the accumulation of more than $4 trillion of assets on the Fed’s balance sheet, compared with less than the $900 million it held before the GFC.

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Updated On : 12th Aug, 2019

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