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Case Commentary on

Fed Keeps US Interest Rates Unchanged

By

Howard Schneider and Ann Saphir

(Manila Bulletin, September 19, 2015)

MARY FRANCEL D. ABLAO


MBA
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Last September 15, 2015, the US Federal Reserve decided to keep their interest

rates unchanged in a bow to worries about the global economy, financial market volatility

and sluggish inflation at the US. Fed Chair Janet Yellen said developments in a tightly

linked global economy had in effect forced the US central banks hand. This move by the

US Federal Reserve caused some Asia- Pacific central bankers speculate that rather than

containing global economic uncertainty, it rather added to that uncertainty. Bank Indonesia

Senior Deputy Governor Mirza Adityaswara said that it would have been better if the US

Federal Reserve increased its historically low rates to create stability in emerging markets

and enable them to continue developing and reforming their economies. These reactions

came despite broad recognition that a Fed increase of short-term interest will prompt

investors to pull money out from emerging market countries in Asia. Many investors still

believe that the US will increase rates this year which will intensify the strain on developing

nations that are already struggling with slowing growth, substantial debt and crumbling

demand for commodities.

Overnight rates refers generally to the cost charged to banks for borrowing money

from Federal Reserve Banks. In the USA, the central bank uses this rate to influence

monetary policy. This is important for investors to decide on which type of investment will

yield a better return.

Interest rates and inflation are directly related to each other (Reilly & Brown, 2012).

These two are part of the six key economic variables which provides significant

information about the macroeconomy. Inflation is the measure of how fast the overall level

of money prices is rising. Inflation is influenced by consumer spending and consumer

spending is directly affected by the availability of money for consumers to spend.


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Therefore, if interest rates are lower, consumers tend to borrow money and have a surplus

of cash to spend on both necessary and luxury items whereas if interest rates are higher

consumers are deprived of borrowing resulting in lesser quantity of available cash to spend

and they expend on necessary things. Moreover, when investors anticipate an increase in

the rate of inflation, we would expect them to increase their required rates of return by

similar amount to derive constant real rates of return (Reilly & Brown, 2012). There are

two types of interest rates, we have the nominal and real interest rates. Nominal interest

rates is the rate in terms of money which does not take into account the effects of inflation.

While real interest rates is the rate in terms of goods and services which takes into

consideration the effects of inflation. To derive real interest rate, it will be the nominal rate

plus the premium for expected inflation. Investors are concerned in these two variables

because from these they can speculate on the economic conditions and decide whether it is

a good time to invest or not and where to invest their money.

In light of the issue pertaining to the move of the US Federal Reserve to keep their

interest rates at bay to address the global economic uncertainty, it is true that it affects the

position of emerging economies of developing countries especially in the Asia Pacific. The

problem in consumer spending in the US affects the inflation rate which also directly

affects the economic condition of the country. They aim to encourage their citizens to

borrow money at a lower interest rate and increase their spending. Moreover, since the US

is composed by small businesses in majority, they are encouraged to invest more and

increase their economic activity. The increased spending and investing activity of local

individuals and businesses will contribute in a better flow of money and inflation will

increase at a normal rate which affects the economy as a whole. This fiscal policy of the
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US affects developing countries because many investors are encouraged to pull out and

park their money where they expect the stock market in a bull state. On the other hand, the

speculation that many investors will still pull out their money when the US Fed Reserve

increase their interest rates from the emerging markets is also true. The USA funds their

economic activities also through borrowings, therefore, creditors are more encouraged to

invest their money in the US where they expect a higher rates of return.

Investors aim to maximize their wealth and these information are important. To

address worldwide market uncertainty, one country should have a strong fiscal policy.
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References:

Mueller, J. (2006). How Interest Rates Affect The Stock Market. Retrieved from the

Investopedia website: www.investopedia.com/articles/06/interestaffectsmarket.asp.

Overnight rate. Retrieved from the Wikipedia website:

https://en.wikipedia.org/wiki/Overnight_rate.

Reilly, F.K., & Brown, K.C. (2012). Investment Analysis & Portfolio Management. South-

Western, Cengage Learning: Ohio.

Schneider, H. & Saphir, A. (2015, September 19). Fed keeps US interest rates unchanged.

Manila Bulletin, p. B1.

Six Key Economic Variables. (2001). Retrieved from the Standford website:

http://web.standford.edu/class/msande247s/econVariables.ppt.

Six Key Economic Variables. (2004). Retrieved from the Management- Class website:

www.management-class.com/courseware/strategic/tutorials/keysix.ppt.

WSJ. (2015, September 19). Fed move prolongs market uncertainty. Manila Bulletin, p.

B3.