The Federal Reserve Bank plays a major role in regulating the US economic performance. Effective June 17, 2021, the Federal Reserve Bank board of governors voted to retain the Federal Fund Rate between 0 and 0.25 percent ( Federal Reserve Bank, 2021). The measure is expected to encourage the economic recovery of the various sectors and to support the growth of employment opportunities. The Federal Reserve also expects that the decrease in the Federal Fund Rate will increase the inflation rate slightly above the target 2%. The Federal Reserve, however, intends to retain the long-term inflation average at 2%.
Retaining a low Federal Fund rate of between 0 and 0.25% means that the banks will recapitalize at lower rates by borrowing from the Federal Bank, lender of last resort. Therefore the lending interest rates will remain low or decline as long as the rates are between 0 and 0.25 percent (Mankiw, 2020). Low interest rates encourage households and businesses to borrow more for consumption and investment, respectively. Therefore, businesses will invest more as the demand for products and services grows, hence creating more employment opportunities (Mankiw, 2020). The Federal Reserve action will cause a right shift to the aggregate demand curve, creating more consumption and investment and creating employment opportunities. Continued low federal fund rates may lead to inflation as the demand for products/services exceeds supply, causing the sellers to increase prices. Therefore, to retain an inflation rate of close to 2%, the Federal Reserve may have to increase the Federal rate in the future.
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A potential increase in the federal fund rate in the future would cause a left shift in the aggregate demand. A higher federal fund rate means that banks recapitalize at higher interest rates, causing an increase in lending rates ( Federal Reserve Bank of St. Louis, 2010 ). Higher lending rates discourage borrowing by institutions and households hence decreasing the level of investment and household consumption. Since the Federal Reserve goal is to maintain the inflation rate closer to 2%, the increase in the federal fund rate is also expected to be minimal to avoid a significant shift in the aggregate demand curve to the left, which would reverse the economic stimulation gained through retaining a low federal fund rate.
Possible higher federal fund rates are expected to increase the interest payable on debts owed by Bata firm. As the consumers struggle to pay higher interest rates on the loans, household consumption is expected to decline, hence the sales for Bata ( Federal Reserve Bank of St. Louis, 2010 ). As interest expenses increase, the overhead expenses of Bata are expected to increase relative to the declining income. To avoid losses, the company would be forced to cut costs through processes such as retrenchment of employees, cutting on production to reduce inventory, and reducing investments in new products.
In the alternative, retaining a low federal fund rate means lower interest expenses for Bata Company and households. Low-interest expenses reduce the overall costs for the company and provide new borrowing opportunities for purposes of investment (Mankiw, 2020). The demand for Bata products is also expected to increase as the households borrow more for expenditures due to lower interest expenses. Higher demand for products requires an increase in production capacity and hence the employment of additional human resources.
In conclusion, the Federal Reserve action of retaining the federal fund rate between 0 and 0.25 percent will help stimulate economic growth. However, the Federal Bank will have to increase the rate in the long term to avoid an increase in inflation rates. Higher interest rates reduce demand for products, increase companies’ interest expenses, lay down workers, and decrease expenses.
References
Mankiw, N. G. (2020). Principles of economics . Cengage Learning.
Federal Reserve Bank. (2021). The Fed - Meeting calendars and information . Board of Governors of the Federal Reserve System. https://www.federalreserve.gov/monetarypolicy/fomccalendars.htm
Federal Reserve Bank of St. Louis. (2010, October 1). Low interest rates have benefits ... and costs . Federal Reserve Bank of St. Louis | Economic Data, Monetary Rates, Economic Education. https://www.stlouisfed.org/publications/regional-economist/october-2010/low-interest-rates-have-benefits--and-costs
