Published: February 18, 2016
Central bankers across the world are frantically trying to implement policies that will rouse their respective economies and assuage investors’ fears. The BOJ (Bank of Japan) and the ECB (European Central Bank) have recently turned to negative interest rates as a last ditch effort to stimulate economic growth and increase inflation. Meanwhile, the Federal Reserve has increased interest rates in a United States economy that has fared relatively well in a tumultuous global environment. This monetary dichotomy between the United States and other developed economies will have significant economic repercussions. “I’m curious to see how these divergent policies will affect unemployment and the price level,” said David Yatsonsky, a senior BCMB major who was speaking out of his discipline.
The ECB recently cut its deposit rate to -0.3 percent and a report by JP Morgan predicts that the rate may fall as low as -0.7 percent this year. Japan, who has been dealing with low inflation deflation for decades now, had its deposit rate cut to -0.1 percent by the BOJ. Historically, lower interest rates engender higher inflation and economic growth, but these two effects have been muted lately. Europe and Japan have enjoyed historically low interest rates for years, but inflation was only 0.2 percent in the Euro Area and Japan in December. Low rates have also failed to bring about growth, as the GDP only grew by 0.3 percent in both the euro area and Japan in the later stages of 2015.
The United States’ monetary policy has been the antithesis of the policies of Japan and Europe. The Federal Reserve has kept its benchmark Federal Funds Rate near zero percent since the Great Recession, but it upped the range of the rate from 0 to 0.25 percent to a range of 0.25 to 0.5 percent in December and is expected to incrementally increase the rate throughout 2016. Inflation was 0.7 percent in the United States in December. That inflation rate, while significantly higher than the rates in Europe and Japan, is still well below the Fed’s target rate of a two percent. The Federal Reserve targets a two percent inflation rate because it believes that two percent is the best rate to maintain price stability and maximum employment. Dr. Ghosh, a professor of economics, remarked that, “a low inflation rate is not bad for the economy, but deflation can have adverse effects.” A two percent inflation rate is not high enough to hurt purchasing power, but it is high enough to stave off deflation. The United States also recorded a relatively strong GDP growth rate of 1.5 percent in the fourth quarter of 2015. Although the Fed was wary about raising rates due to low inflation, a strong growth rate and job market provided the necessary impetus.
This stark contrast between the monetary policies of the United States and Europe will have a plethora of effects. On both nations perhaps the most notable are the appreciation of the dollar and the depreciation of the Euro. Higher interest rates will attract foreign investors, who will expect higher returns, and the demand for the dollar will increase. This increase in demand will cause the dollar to appreciate against other currencies. These exchange rate fluctuations will have far reaching economic consequences. As a currency appreciates, the exports of that country become more expensive and its imports become cheaper. This can have adverse effects on the economic growth of a country, as exports increase GDP and imports decrease GDP.
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