What does the fed rate cut to 0% means
Read Time: 4 mins
As we all know amid the coronavirus crisis, the USA has cut the Fed rate to 0% to increase liquidity and furthermore to prevent the market to fall, whose probability currently stands at more than 50%. Let's have a look at what the current scenarios are in the global market and let's understand what this rate cut from the very basics.
Market Volatility
Currently, the market stands at a very thin rope and can head to any direction based on the changes in the global circumstances. In brief, the factors such as the pandemic coronavirus, the oil price war between Russia and OPEC, the conflicts between US and Mexico, the Isreal-Palestine issue and many more stand as the core reason behind such volatility in the market and especially the lockdowns due to Coronavirus is affecting a lot of markets globally. To understand more about the factors affecting the market, I'll suggest a read to this blog on "Why the market is plunging".
With such disturbances in the world, the global economy is falling and the deficits are increasing. In such a market people tend to take their money out and put them in a safer place and tend more towards keeping cash in hand. When people get away from investing, companies go to an undersupply of money to run their business, thus are not able to generate money and further leading to loss-making businesses and thus filing bankruptcy. So the more, the people take their money away from the market, the more, the chance of recession. To prevent such scenarios to happen, the government regulates the policies and makes changes to gain people's confidence in the economy so that people vest their money into the market.
What is Fed Rate?
The Federal Funds Rate, also known as the Fed Rate, refers to the interest rate that the central bank charges other banks for lending them excess cash from their reserve balances on an overnight basis.
The banks are legally bound to keep a reserve equal to a certain percentage (currently at 10%) of their deposits in the Federal Reserve bank.
Reserve Balances: It is basically the minimum amount of cash that the banks or the financial institutions need to have in order to meet the central bank requirement.
The rate is well appreciated by the President of the United States as well. President Donald Trump on Sunday i.e. March 15, praised the Federal Reserve's move that is to slash the interest rates to near zero in a bid to support the economy during the coronavirus pandemic, calling it a "big step."
Now with such a low fed rate, the interest rate for the general public and for the organizations provided by the banks and the financial institutions will also decrease. This decrease in interest rate will lead to higher purchasing power and to a more liquid economy. It will definitely act as a positive measure to help the current economy and will lead to a better and more stable economy, also many investors who were taking their money out of the market will be re-investing their money thus stabilizing Wall Street as well.
However, the stronger purchasing power increases the probability of stupid/loss-making purchases as well and that activity if grows at a large scale can worsen the economy rather than stabilizing it. So the fed rate cut to near 0% can worsen the economy as well but based on all the factors it holds a brighter chance to stabilize the economy rather than worsening it.
The banks are legally bound to keep a reserve equal to a certain percentage (currently at 10%) of their deposits in the Federal Reserve bank.
Reserve Balances: It is basically the minimum amount of cash that the banks or the financial institutions need to have in order to meet the central bank requirement.
The News
The Federal Reserve recently lowered the fed funds rate. The range of rate currently stands between 0.00%-0.25% as of March 15, 2020. The Fed Chairman, Jerome Powell, said in a press conference that, "We do not see negative policy rates as likely to be an appropriate policy response here in the United States"
As is clear by the name, A negative interest rate policy (NIRP) is a very unusual monetary policy in which the minimum target interest rates are negative.
What does the rate cut mean?
The rate cuts are done to enhance the liquidity in the market and to remove the economic stagnation if any. When the economy is down, as it is currently, people take their money out which leads to less liquidity, to manage these scenarios the Federal Open Market Committee (FOMC), the committee that frames the monetary policies of the Federal Reserve System, meets 8 times a year to set the fed rate. The FOMC base its decisions about the rate adjustment on certain economic indicators which can link to inflation, recession, or other similar factors.The rate is well appreciated by the President of the United States as well. President Donald Trump on Sunday i.e. March 15, praised the Federal Reserve's move that is to slash the interest rates to near zero in a bid to support the economy during the coronavirus pandemic, calling it a "big step."
Now with such a low fed rate, the interest rate for the general public and for the organizations provided by the banks and the financial institutions will also decrease. This decrease in interest rate will lead to higher purchasing power and to a more liquid economy. It will definitely act as a positive measure to help the current economy and will lead to a better and more stable economy, also many investors who were taking their money out of the market will be re-investing their money thus stabilizing Wall Street as well.
However, the stronger purchasing power increases the probability of stupid/loss-making purchases as well and that activity if grows at a large scale can worsen the economy rather than stabilizing it. So the fed rate cut to near 0% can worsen the economy as well but based on all the factors it holds a brighter chance to stabilize the economy rather than worsening it.
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