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Is Monetary Policy the solution to a slowing economy?

We look across the pond after the US recently cut its interest rates.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

It’s a tough time to know where to invest. There’s uncertainty across the globe; from trade wars, to Brexit, to tensions in the Middle East.

Global annual GDP growth – how we usually measure the economy’s health – is set to fall again to 3.2% this year, down from 3.6% in 2018. And other economic indicators like manufacturing activity are signalling further trouble ahead.

Prominent manufacturing nations including China and Germany have all seen a decline in activity so far this year.

What can a central bank do to stimulate the economy?

Central banks can change the base rate of interest, known as the Federal funds rate in the US, or Bank of England base rate in the UK. When they’re concerned about the economic outlook, central banks tend to cut the base rate, which should in turn mean banks cut the interest rates they offer on loans and savings.

This makes it more attractive for businesses to borrow and invest, as it costs less in interest payments.

It’s also less attractive for consumers to save, as they get less interest on their cash. This should encourage them to spend, and flow money back into the economy.

The chart below shows how Federal fund rates in the US have changed over an economic cycle.

Federal funds rate vs. rate of inflation

Source: Refinitiv to 31/07/19

Central banks also have the ability to create new money. This is known as quantitative easing or QE, and the idea is to increase the amount of money available to lend.

Another way they can alter the money supply is through changing the reserve ratio. This is the share of deposits that banks have to hold onto, rather than lend out or invest. Lowering the reserve ratio lets banks lend more of the money they receive from customers, increasing the amount that’s moving around the economy.

Why does Trump want the US Federal Reserve to keep cutting interest rates?

Traditionally, US politicians have avoided openly criticising the Federal Reserve, allowing it to operate independently in the long term interests of the US economy. Current US President Donald Trump however, has been very vocal in his criticisms of the Fed, and in particular Chairman Jerome Powell, for being too slow to lower interest rates.

In fact he recently called for the Fed to slash interest rates to zero or even negative to boost the economy. An unwelcome proposal met with disapproval by many economists.


The President is now in his third year in the White House and with Americans set to go to the polls again in November 2020, he’ll be acutely aware that no US President has been re-elected while the economy is in recession.

America first or Trump first?

Trump thinks his America-first agenda is being held back by the Fed. But critics see his accusations as a politically motivated effort to set up someone to blame should the US economy worsen.

Trump might also be antagonised by action from other global central banks. In September the European Central Bank (ECB) cut its base rate to an all-time low of -0.5% and restarted its quantitative easing programme. Following the rate cut, the dollar strengthened against the euro.

This type of currency movement is painful for American exporters, as overseas customers will find their products more expensive. This makes American businesses less competitive on the international stage.

What will the Fed do next?

With an uncertain global outlook, policy at the Fed remains under close scrutiny. Just last month, the US Federal Reserve Open Market Committee was divided on how best to move forward with interest rates. The federal funds rate range was cut to 1.75%-2.00%, despite two members voting to hold rates steady.

Some economists think the key to growth lies not with the Fed, but in relations between the White House and Beijing. A resolution to the trade war would go some way to restoring confidence in the economy. But if a resolution isn’t forthcoming, it’s likely central banks will again be expected to find a way to keep the economy expanding.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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