US, Global Economies Face Inflation, Federal Reserve Holds Steady

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US, Global Economies Face Inflation, Federal Reserve Holds Steady

U.S. economy, inflation and the Federal Reserve

The U.S. Federal Reserve opted to keep interest rates level for now. Meanwhile, countries around the world facing their own inflation have started to increase interest rates. Some say this crackdown will help the United States; others say until the United States raises its interest rates, the entire global economy will suffer.

INTERNATIONAL INFLATION: The Federal Reserve System announced its plan to keep interest rates steady for the first time since it began lowering them last September. Analysts say this move indicates a switch of focus—from stimulating a recessionary economy to stemming spiraling inflation. The European Union, Mexico and India also plan to address their inflation with interest rate increases, which may boost the U.S. economy.

by Patricia McFadden
Informify Staff Writer
June 30, 2008

The Fed announced last Wednesday that it would not lower interest rates any further, and may in fact raise them in the near future. The European Central Bank (ECB) has announced a .25% interest rate hike in July in an effort to curb growing inflation in the European Union. With the international exchange rate for the U.S. dollar at an all-time low, increased interest rates abroad may strengthen the dollar's value.

Rising Inflation Affects More Than 40% of World Population

Friday the cost of crude oil hit a record high at $142 a barrel. Recent flooding in the Midwest destroyed more than 1.3 million acres of corn and 2 million acres of soybeans, which drove up grain costs to record highs. In turn, Americans can expect fuel and food costs to go up.

But the United States isn't the only country facing economic woes.

India—saw its highest inflation rate in 13 years this month; raised interest rates twice in June

Mexico—raised interest rates in June for the first time in eight months; depends on United States as its largest trading partner

China—raised government-subsidized prices for gasoline and diesel in June

European Union—announced last Thursday plans to raise its interest rate one-quarter of a percent in July; noncommittal about future rate increases

Spain (part of the EU)—saw its highest inflation rate in 11 years this month at 5%

According to Morgan Stanley economist Joachim Fels, 50 countries face inflation rates in the "double digits." (International Herald Tribune, 6/29/08) In fact, more than 40% of the world's population face climbing prices that may cripple their economies.

US Reserve Waits While other Countries Raise Interest Rates

Since prices across the globe are going up, U.S. Federal Reserve Vice Chair Donald Kohn said an international approach to stabilizing global prices is needed.

"Policy makers around the world must monitor the situation carefully for signs that the increases in relative prices globally do not generate persistently higher inflation," said Kohn last Wednesday. (International Herald Tribune, 6/29/08)

Recent interest rate hikes in Mexico, India and the EU may indeed slow global inflation—moderately.

But what could really help the global economy? Raising interest rates in the United States, according to some economists.

"Given the overall very easy stance of global monetary policy," Fels said, "a massive global tightening of monetary policy is thus unlikely, especially if the Fed keeps interest rates low for a considerable period." (International Herald Tribune, 6/29/08)

Other Countries' Economies Depend on U.S. Economy

Until recently, the U.S. dollar was one of the strongest currencies on the international market. Many countries have, therefore, based their economies on the American dollar.

As a result, these countries kept their interest rates low to discourage their investors from dumping U.S. dollars and buying other currencies.

Many Asian countries, in particular, have interest rates far below their rate of inflation:

Country	Inflation Rate	Interest Rate
Indonesia	10.4%	8.5%
Philippines	9.6%	5.5%
India	11%	8.5%

If these and other countries decided to raise their interest rates, a currency crash could lead to major inflation in America and abroad.

Question for Readers:

Have you traveled abroad recently? How did the dollar's exchange rate impact your trip?

Recession is a slump in the economy. A recession occurs when...

employment,
investments and
corporate profits

drop simultaneously for two or more consecutive quarters.

The Federal Reserve traditionally responds to a recession by lowering interest rates in order to stimulate spending.

For instance, if you can get a good interest rate on a car loan, you're more likely to buy a car.

Inflation is the reduced purchasing power of money-the dollar doesn't goes as far as it once did. Inflation occurs when prices go up and remain there. It can happen for one of two reasons:

Cost-push—rising costs of goods (usually caused by an increase in cost of raw materials) causes everything to go up in price.
Demand-pull—amount of money in circulation surpasses the amount of goods and services for sale.

The Federal Reserve traditionally responds to inflation by raising interest rates, which motivates people to save more since money in savings will earn interest. If more money is put into savings, there's less in circulation, making the money that's out there worth more.

For instance, if the interest rate goes up for a car loan, you're more likely to keep your money in savings and keep your old car than buy a brand new car.

(Source: Wikipedia)

The U.S. government established the Federal Reserve System in 1913 with the passage of the Federal Reserve Act. It is a quasi-governmental organization, meaning it's supported by the government but run privately.

As the central banking system for the United States, the Fed serves many purposes:

Prevents "banking panics" in which bank customers withdraw their money all at once from financial institutions.
Serves as the central bank for the United States, making sure the country's financial transactions (government and private) are safe and efficient.
Processes federal income tax deposits and payments.
Distributes the money that the U.S. Treasury produces.
Balances private bank interests with the government's responsibility to the people by regulating banking institutions and protecting consumers' credit rights.
Sets the nation's money policy, including interest rates.
Maintains the country's financial stability by limiting market risk.
Provides financial services to banks, the U.S. government, and foreign institutions.
Helps regions across the country exchange money by responding to their local needs.
Strengthens the United States in the global economy.