Usa Increasing Interest Rates

The article discusses USA potentially upping interest rates above the neutral rate to slow down growth. The federal reserve tries to set stability and a “soft landing,”, after the increasing growth from fiscal policy and the growing trade tensions.

Contractionary monetary policy is when the central bank increases interest rates. Because consumers will be incentivised to borrow less and save, investment and consumption will decrease, decreasing aggregate demand as they are key components for calculating aggregate demand.

Neutral interest rate is when it is equal to the inflation rate.

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The diagram shows that the policy has slowed economic growth. At first, Ad1 would shift to Ad2, changing the GDP from y1 to y2. However now growth has slowed down so Ad2 will only shift to Ad3, and y2 will only shift to y3 (before equilibrium change E1-E2, now E2-E3). We know the economy tending towards full capacity as the article stated USA’s fiscal policies would “push it close to full capacity utilization.” Therefore, GPL will remain constant.

This shows that decrease in economic growth will be able to stabilize the economy if it has been growing rapidly, which we know can be a bad thing. The consequences are namely income distribution and inflation. Rapid economic growth might only benefit a small number of top-earning people, and others might not be able to afford a higher cost of living if the general price increases. It can also experience higher rates of deforestation, industrial pollution, and negative externalities of consumption/production, which this policy would help face.

There can be situations where the policy is not effective, and it depends on where the economy is situated. If we are producing at full capacity then the shift in aggregate demand will only be in the inelastic portion of the supply curve. This can only slow down inflation, which isn’t the original objective. Although this can still keep steady inflation, there will be no more growth.

In the long run, the monetary policy could also apply to aggregate supply, since a decrease in investment would affect suppliers who invest in machinery and equipment maintenance, potentially stopping or slowing the development of quality and quantity of factors of production.

However even worse off are individuals who have to borrow large sums of money for things like cars or university payments. The increased interest rate will have little effect on how much they borrow due to the necessity of these services. This can cause lower income households to build large sums of debt.

On one hand, private banks are also negatively impacted, because they make a large portion of their profit from consumer borrowing, which would decrease with the policy. However, saving would increase, which makes more funds available for loans, therefore one could argue that they could also profit.

Any consumer who decides to save their money will now be earning more money than the inflation rate, since there is an expected “increase interest rates beyond neutral.” Either for the unemployed, or people who have sufficient money to live off their interest, they are best off.

The government benefits too, because they can have the federal reserve take care of the cushioning and stabilizing while they try to keep on boosting the economy. There might be a mismatch between their priorities and the fed’s however. A government can disregard the environmental impact of growth, whilst the federal reserve does and could soften growth too much for them