From Beijing to Federal Reserve

This article is contributed by Chitty Li He. 

Ever since the rout of Chinese stock market, the financial world has been ruminating on the association between the realities of China’s economic growth and the Fed’s schedule on hiking interest rate. From where I stand, the influence of Chinese stock market crash that analysts place on predicting when the Fed will move from a zero interest rate policy is overstated.

Though we cannot discount the impacts of foreign economies on the Federal Reserve’s decision, it is my belief that the Fed will place greater emphasis on domestic economy. An increase in interest rate in the U.S. will increase the borrowing cost for its customers and thus reduces their disposable income. By encouraging people to save more and spend less, the demand for goods and services drops, and ease the inflationary pressure. After the financial crisis in 2008, the U.S. economy is witnessing a recovery – relatively low unemployment rates, controlled inflation and rosy economy promises. However, the market has presented challenges for the Fed to keep the Fed funds rate below its target level since the Fed’s decision to increase interest rate 6 years ago. For the purpose of taking hold of the economy and controlling inflation effectively, the Fed will be more likely to pay great attention to domestic inflation rate and other important signalling indices.

Although some Fed officials quote China’s impact on the interest rate decisions, it is the realities of China’s real economy that are really affecting the overall performance of the U.S. economy, and thus the Fed’s resolve to hike interest rate. However, whether the recent stock market slump can objectively reflect the development of China’s real economy is questionable. When Chinese bull stock market soared to all times high in 2015, the domestic companies’ revenue and household balance sheets did not seem to increase that much. Though there have been speculations involving the decreasing investment, Chinese government is implementing policies to stimulate consumption and expand the scale of service sector. Additionally, concerns and doubts regarding Beijing’s commitment to deepen its financial reforms, especially right after the government’s stock market intervention arise in the western world. However, evidence suggesting the linkage between the lackluster stock market and the realities is weak. In this aspect, we have no reason to link these two simultaneous events together.

From what is discussed above, we can safely justify that the Fed’s interest rate decision will be based more on domestic economic performance rather than the fate of some foreign economies like China.

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