Economic Stability or Defending Dollar? US Fed Has a Tough Task

For a country to have Stability and handle turmoil, the balance between Interest rates, Economic growth, and global currency is very important. A similar scenario has emerged in the United States which can affect the country's financial markets and the global economy.

Economic slowdowns and significant risks to the stability of the financial system can be seen, when nominal interest rates, such as those on government bonds, exceed the nominal growth rate of a country's economy.

Here are some repercussions:

1. Government Debt Burden

2. Corporate Challenges

3. Household Struggles

4. Banking Sector Woes

5. Rising Risk Aversion
   

Earlier all the Countries central banks worldwide have traditionally recycled their current account surplus in US assets, creating a symbiotic relationship. However, the spending Spree in COVID-19 and recent events notably Russia-Ukrainian conflict and the Israel-Gaza strike have disrupted this flow of funds. US current account deficits could now trigger dollar depreciation unless the United States entices capital inflows by increasing Interest rates.

Earlier the flow of funds was from the United States to the world. Now things have changed and the United States depends on Foreign inflows to maintain stability. So Today, Capital is flowing from the rest of the world into the United States.

This is one reason why Asian countries are not affected by the rising interest rates in the United States.

Because of this, the US faces the dilemma of whether should they focus on domestic economic stability or safeguard the value of the dollar?

The answer leans towards the domestic economy, as the United States' current account deficits increase the risk of deprecations in the dollar. Increasing the interest rates entices capital inflows which will help in economic stability as well as defend the dollar's value.

Thank you.

Regards,

Milan Purohit,

Kautilya, IBS Mumbai.