User's blog

Tag: macroeconomics

  • Do you have FOMO when you invest?

    Everyone experiences FOMO, which is the Fear of Missing Out on various aspects of life, but it’s crucial to resist it when making investment decisions. In today’s post, we will learn why I made that statement.

    FOMO stands for “Fear of Missing Out.” It’s when people feel anxious or worried about missing out on something exciting or profitable.

    Imagine you’re on a road trip. You have a map that guides you to your destination. Sure, you might see some cool attractions along the way, but if you keep changing your route every time you see something shiny, you’ll never reach your destination!

    Similarly, in investing, your long-term plan is like your map. It helps you stay on track and reach your financial goals. While it’s tempting to jump into investments just because everyone else is doing it, you need to stick to your plan.

    When we make decisions solely based on FOMO, it can lead to impulsive choices that might not align with our goals. So, remember, while it’s okay to feel FOMO, it’s essential to have strong willpower and stick to your long-term plans.

    You can do that by practicing this phrase called “NO GO to FOMO”.

    “NO GO to FOMO” means saying no to impulsive decisions driven by FOMO.

    Instead of making quick decisions because everyone else is doing it, this phrase reminds investors to think carefully before acting. If your friends are all buying a certain stock because they think it will make them rich quickly. But you’re not sure if it’s a good investment for you, so you don’t blindly follow everyone.

    “NO GO to FOMO” reminds you to take your time, do your research, and only invest when you’re confident that it’s the right choice for you.

    Various investment opportunities like digital assets, meme stocks, and NFTs are gaining popularity because many influencers often promote these. The SEC emphasizes caution against FOMO, reminding investors not to follow others blindly.

    Investors should not base their decisions solely on recommendations from influencers and should resist the temptation to follow trends blindly.         

    Do you react to market swings?

    Reacting to market swings due to FOMO can be harmful to financial stability due to these reasons:

    1. When people react to market swings because of FOMO, they often make decisions without thinking them through. They might buy stock or sell them just because everyone else is doing it and they get afraid of missing out on profits.
    2. But the truth is, reacting impulsively like this can actually hurt your financial stability in the long run. Market swings are normal, and they don’t always reflect the true value of investments. Reacting to them based on FOMO can lead to buying high and selling low, which is the opposite of what you want to do as an investor.
    3. It can also cause you to miss out on real opportunities because you’re too focused on what everyone else is doing.


    Building a diversified investment portfolio can lessen risks that come with market volatility

    Diversification means spreading your investments across different types of assets, like stocks (which are like shares of companies), bonds (which are like loans you give to companies or governments), real estate (which is a property like a house or land), cash in checking and savings account and commodities (like gold, silver, oil, etc).

    Diversification within asset classes and avoiding timing the market are essential strategies to protect your investments. You can diversify within each type of investment too. For example, if you’re investing in stocks, you might choose different companies and industries. This you can easily do by buying ETFs or Index funds.  I have made several posts on that so you can check those out by searching these two terms.

    Also, it’s important not to try to time the market (which means predicting when to buy and sell investments based on what you think the market will do). Instead, focus on the long-term and stay diversified.

    What Should You Fear Missing Out On? **

    The first thing should be not planning for your future and setting Long-Term Goals

    You need to start prioritizing financial planning if you haven’t done already. This means setting long-term goals, like buying a house, saving for your children’s education, or planning for retirement. Having a clear plan helps you stay focused and make smart decisions with your money.

    The second thing is Not Paying Off High-Interest Debt like credit card loans

    Paying off high-interest debt should also be a priority. It’s like getting a guaranteed return on your investment because you’re saving money on those high-interest payments. So, please include paying off credit card debt or other high-interest loans in your financial plan.

    3rd is Not taking advantage of the Power of Compounding

    Start saving early and consistently. The power of compounding means your money grows over time, and the earlier you start, the more you benefit. Even small, regular contributions can add up significantly over the years and I will show you this through this calculator. Where you can see how by just investing $100 every month, you can make a lot of money in the future, if I just change the time horizon, see how exponentially your money can grow, with interest payments becoming the biggest factor of your total returns, as the years pass.

    The fourth mistake or what you should FOMO is Not taking advantage of free money through Employer-Sponsored Retirement Plans

    Don’t miss out on participating in employer-sponsored retirement plans like a 401(k), especially if your employer offers matching contributions. This is like free money and can lead to significant returns over time. This will ensure you have a secure retirement financially.

    So, remember to prioritize financial planning, pay off high-interest debt, start saving early, and take advantage of employer-sponsored retirement plans to ensure a brighter financial future.

    Successful investing requires discipline, patience, and a long-term perspective, not reacting impulsively because of FOMO.

  • The easiest way to earn passive income

    The easiest way to earn some passive income without doing any work is when you move your savings into a high-yield savings account from your traditional savings account at some big banks.

    A high-yield savings account also known as a high-interest savings account gives you a much higher interest rate compared to a traditional bank savings account.

    Because these banks are mostly online, they save on overhead expenses and pass that savings to their customers. Most HYSAs are online, but you can find high-yield options in some regular banks too like Barclays, Marcus by Goldman Sachs, Amex, etc. We will go over these in a moment.

    Why you shouldn’t save at traditional savings accounts?

    Traditional big banks like Bank of America, Chase, Wells Fargo, and Citibank pay AMLOST 0% interest on your savings, which means you lose money by keeping your savings there.

    Their annual percentage yield or APY or interest rate is as low as 0.01%. This rate is so low compared to the inflation rate, that you end up losing money instead of gaining any return by keeping your money in a traditional savings account.

    How is HYSA better?

    So, the best way to have a guaranteed return that can match the inflation rate is to put your money in a high-yield savings account.

    When we get a higher interest rate on our savings, our savings grow faster with time. It’s the ultimate set-it-and-forget-it way to make your money work for you, without any risk.

    Most of these banks are FDIC insured, which means you will have protection by the US government for deposits up to $250, 000. If you save more than that, you should go with more than one bank as the insurance covers up to 250,000 from each bank failure.

    The best part about savings in high-yield accounts is that they are not risky, like stocks or other business-like investments. they are a safe and steady way to watch your money grow.

    Since the rate hikes by the Federal Reserve rate, APYs of high-yield savings accounts have been going on the rise, so this is a great time to put your savings in a high-yield savings account. Even though their rates can change a bit, based on the Fed’s decision about overall interest rates in the economy,  their rates are still much higher compared to traditional savings accounts.

    The options I am going to share have annual percentage yields, or APYs, from 4.3%-5.3%, which is way more than the national average rate of 0.47% at traditional savings accounts and in particular, at large national banks, which give you rates as low as 0.01%

    Currently, rates at the best high-yield accounts earn around 5.5% APY. This information is current as of Jan. 28, 2024.

    Here’s a list of some of the top FDIC-insured High-Yield Savings Accounts (HYSA) for January 2024. The table includes information on fees, APY (Annual Percentage Yield), and minimum balance requirements. Each of these has a user-friendly app and Easy-to-use online and mobile banking features.

    Please note that the specific fees and APY can change, so make sure to check the respective bank’s website for the most accurate and up-to-date information. All this information I compiled is latest as of Jan 28, 2024.

    What to look for when picking a High-Yield Savings Account?

    1. Interest Rate (APY): Aim for the highest APY – it’s the key to growing your savings quickly.
    2. Fees: Choose an account with no monthly fees or extra charges. We want all that money in your pocket!
    3. Minimum Balance: Look for accounts with no minimum balance requirement. Whether your savings are big or small, you start earning interest right away.
    4. Security: Make sure the bank is FDIC-insured to keep your money safe. Check out online reviews for that extra peace of mind.
    5. Perks: Some HYSAs come with cool perks like welcome bonuses or nifty budgeting tools. Keep an eye out for those extra goodies!
    6. Accessibility: Easy-to-use online and mobile banking features are a must. We want you to stay in control without any hassle. I have most of my savings in Ally Bank and I will show you exactly how much difference if I were to keep my savings in a big brick-and-mortar bank like Bank of America or Chase. You can go to their website and see how it compares to leading banks when you deposit money there. So if I have $12000 saved there, after one year I will get $522 at 4.35% interest. The good thing about this is that they have savings buckets. Like digital envelopes, where you keep your cash for whatever you want to do). You can use them to track your progress. Ally Bank has become sort of the gold standard of online banks, and for good reason. It has consistently high-interest rates and is easy to use. Ally also offers checking accounts, money market accounts, and CDs.

    Which bank am I using?

    I have most of my savings in Ally Bank and I will show you exactly how much difference if I were to keep my savings in a big brick-and-mortar bank like Bank of America or Chase. You can go to their website and see how it compares to leading banks when you deposit money there. So if I have $12000 saved there, after one year I will get $522 at 4.35% interest. The good thing about this is that they have savings buckets. Like digital envelopes, where you keep your cash for whatever you want to do). You can use them to track your progress. Ally Bank has become sort of the gold standard of online banks, and for good reason. It has consistently high-interest rates and is easy to use. Ally also offers checking accounts, money market accounts, and CDs.

    So I think I gave you enough options and reasons to convince your mind. So don’t wait any further and grow your money securely and easily, so you can get to your savings goals faster than you thought. Whether you are saving for a vacation, a wedding, a down payment for your house, or buying a car, you will not regret this decision.

  • What are the Fed’s new monetary policy tools?

    Today we’re going to talk about a really important topic: what are the main tools that the Federal Reserve uses to influence the economy and how does it do it?

    We will also learn the tools that the Fed uses in its new monetary policy and how they are different from their old way. Don’t worry if you’re not familiar with economics, because I am going to break it down step by step.

    So, first things first, what is the Federal Reserve? Well, it’s the central bank of the United States and to put it simply, The Federal Reserve (the Fed) is like a bank for the U.S. government.


    If you look at the Federal Reserve website, it says “One of the most important functions of the Fed is to promote economic stability using monetary policy. The Fed’s goals for monetary policy, as defined by Congress, are to promote maximum employment and price stability.” This means the highest level of employment that the US economy can sustain while maintaining a stable inflation rate of around 2%.

    So how does the Fed control the economy?

    The Fed has some tools to control the economy, these are monetary policy tools. Imagine the economy is like a car. If it’s going too fast and might crash, then the Fed can step on the brakes. If it’s too slow, they can press the gas pedal.

    The FOMC is the money boss

    So let’s understand how the Fed works, The Federal Open Market Committee, or the FOMC is like the money boss of the Federal Reserve. They meet in Washington, D.C., eight times a year to talk about the economy. They look at economic data and statistics, talk to economists, and decide how much interest banks should charge each other.

    This interest is called the federal funds rate. Fed funds rate is the banks’ overnight lending and borrowing rate from each other. This rate matters because it affects how much regular people pay for things like houses and cars. If it’s high, things are a bit more expensive. If it’s low, things are more affordable.

    Let’s understand it step by step, Banks have a place where they put some of their money, called the Federal Reserve. They earn interest on it. Sometimes, one bank has extra money and another needs some to do their everyday stuff. So, the bank with extra money can lend it to the one that needs it. The important part is that the interest rate for this lending is not decided by the big boss or the Fed but by the banks themselves. They agree on a fair rate and it is thus market-determined.

    So how does the Fed steer this key interest rate in the target range set up by FOMC?

    The Fed uses its two administered rates – the first is the interest on reserve balance and the second is the rate on reverse purchase agreement. These are their main monetary tools to control the Federal funds rate in the current times.

    According to the Fed’s chair, Jeremy Powell, “The Federal Reserve sets two overnight interest rates: the interest rate paid on banks’ reserve balances and the rate on our reverse repurchase agreements. We use these two administered rates to keep a market-determined rate, the federal funds rate, within a target range set by the FOMC.”

    When the FOMC wants the fed funds rate to go up, the Fed moves the interest on the reserve balance up. This rate sets the lowest interest rate banks are willing to accept when lending out their money to anyone else. Since banks can also earn this interest by depositing their money at the Federal Reserve and keeping money with the Fed is a safe way to earn money, banks prefer to do this rather than lend it at a lower rate to another bank.

    This acts as a floor for the Federal funds rate, which means the banks will not accept any lower interest rate than this to lend money to one another for a short term.

    Another important concept to understand here is called “arbitrage,” which is like making a profit by buying low and selling high. So let’s say the federal funds rate is 5.5%, and the Fed pays 6% for deposits to be kept at Fed, banks can borrow at 5.5% from other banks and then deposit at 6% to make a profit.

    This pushes the federal funds rate up until it’s close to the interest on reserve balances rate (6%). Similar to the interest on reserve balance which is mainly for commercial banks, the Fed also has other tools, like the “Overnight Reverse Repurchase Agreement Facility,” which is the interest other broader financial institutions can earn by keeping money at the Fed. Thus, it serves the same purpose as the interest on reserve balance and sets a floor for the federal funds rate, which means the federal funds rate won’t go below this.

    The other tool the Fed uses is the Discount Window. Because banks will not likely borrow at a higher rate than they can borrow from the Fed, this acts as a ceiling. It is set higher than the interest on reserve balances rate and the overnight reverse repurchase agreement rate.

    So these are two tools that the Fed is now using in the ample reserves case.

    The Fed’s tools before the 2008 crisis

    The Fed used to use this tool called Open Market Operations as its primary tool, where it bought treasury securities to pump money into the economy. However, after the 2008 financial crisis, it has ample reserves that it only buys government securities to make sure the reserves remain ample in the banking system. So, it uses open market operations only as a supplement tool.

    So how does the FOMC decide on the target interest rate?

    Economic data on inflation and unemployment helps the FOMC decide its target interest rate. Over the years, FOMC has been changing this Federal funds rate target range up and down to help the economy. Think of it like a volume knob on your music player.

    When the economy was in trouble after the 2008 financial crisis, the Fed turned the volume to almost zero to help it get better in 2015.

    Then, when the COVID-19 pandemic happened, they quickly turned the volume back down to almost zero to help the economy during that tough time.

    Most recently, since last June 2022, the Fed has been raising the interest rate to control inflation. As of today, the target range for the Federal funds rate is between 5.25 to 5.50%.

    So, you can think of the Fed as a DJ for the economy, adjusting the volume to keep things running smoothly.

  • How government intervention is needed for social benefit?

    Today, we’re diving into the fascinating world of economics to discuss a crucial concept that often goes unnoticed but has a profound impact on our daily lives – externalities.

    What are externalities?

    Before we delve into examples, let’s define what externalities are. In economics, externalities refer to the unintended consequences of economic activities that affect individuals or entities not directly involved in the transaction. These external effects can be positive or negative, and they often lead to a divergence between private and social costs or benefits.

    Some Examples of Positive Externalities

    1. Education

    To better understand positive externalities, let’s take the example of education. When an individual pursues education, they gain knowledge and skills that benefit them personally. However, education also has positive externalities that extend beyond the individual. When educated people enter the workforce, they contribute to the economy’s productivity, innovation, and overall growth.

    2. Vaccination

    Another example is when the Government provides Vaccination. In the most recent case of the COVID-19 pandemic, people who got vaccines were less likely to get extremely sick or spread the virus to others.

    Similarly, any vaccination for other infectious illnesses provides health benefits not just to the person receiving the vaccine but also to the entire community of people he or she comes in contact with.

    Negative Externality

    Now, let’s shift our focus to negative externalities, using the example of pollution.

    When a factory produces goods, it incurs private costs like labor and raw materials. However, it may also release harmful pollutants into the air or water, causing damage to the environment and people nearby.

    Impact of Externalities

    Externalities can significantly impact market efficiency. When externalities are present, markets may fail to achieve an optimal allocation of resources, leading to overproduction or underproduction of goods and services.

    How can government intervention solve the problem?

    Governments can step in to correct the market failure caused by positive externalities. For example, they may provide subsidies to educational institutions or offer tax breaks to individuals pursuing education. This encourages more people to invest in education, leading to a better-educated workforce and more prosperous society.

    Similarly, to address negative externalities like pollution, governments may impose regulations, taxes, or fines on polluting industries. By internalizing the external costs into the production process, these measures encourage businesses to adopt cleaner and more environmentally friendly practices.

    Conclusion

    Externalities are all around us, influencing our decisions and shaping our economy in both positive and negative ways.

  • The latest inflation report is out! What to expect next from the Fed?

    The bureau of labor statistics (BLS) just released the inflation number for January 2023 for the United States.

    There is a 0.5% increase from the December number, and inflation sits at still a whooping high of 6.4% over the last 12 months from January 2022.

    As you can see in the BLS chart above, the year-to-year inflation is 6.4% for all the items, 10.1% for food, 8.7% for energy, and 5.6% for all the things except food and energy. Also, in their press release, they mentioned the index for shelter was the largest contributor to the monthly inflation number.

    By shelter, they mean rents and owner equivalent rent cost of housing.

    If you look at this detailed table from them, it shows the breakdown in prices for all the individual items.

    Source: BLS


    Under the energy category, fuel oil is still up by 27.7% for the 12 months. Natural gas is also up by 26.7% in the 12 months.

    There is a 14% rise in Dairy and related products in the food category. 

    You can see that the highest inflation happened in cereal and bakery products. This was mainly because of the rise in egg prices because we felt that in the grocery stores.

    What caused egg prices to rise so much?

    Economists think the bird flu was the main reason behind increased egg prices because about 40 million egg-laying hens died in 2022 because of this disease.

     At the same time and the demand for eggs continues to rise because it provides a cheaper source of protein to many Americans. Thus both these supply and demand factors contributed to a significant rise in egg prices. 

    Was this inflation expected?

    This came as a little bit of a disappointment because people were expecting the overall inflation not to rise if not fall from the December level, even though fuel prices seem to be falling.


    Inflation is still high on many essential things, and it continues to be the biggest hit to poor Americans. It acts like an indirect tax on them.

     
    Unfortunately, most of this inflation we are experiencing is caused by supply-side factors, which are difficult to fix in the short run.

    Policy implication

    The government can only focus on controlling the demand aspect of inflation in the short run. As a result, the Fed will continue to tighten the monetary policy and raise interest rates until inflation reaches around 2%

    The federal reserve has been trying to control inflation using interest rate hikes to slow the demand in the economy.


    To learn more about inflation, how it is calculated, and the factors that cause it, please see my post here.

  • What factors influence the exchange rate?

    The exchange rate is the rate at which one country’s currency trades or exchanges against another country’s currency. Simply put, if there are two countries US and India, how many Indian Rupees equate to 1 USD? You can also write it as the ratio of one currency over another currency.

    Many factors influence how the exchange rates are set. In this post, you will learn about those, but first, let’s understand where the currency exchange takes place.

    Foreign Exchange Market is the biggest market in the world by volume and it determines the exchange rates of currencies against each other

    The currency exchange happens in the foreign exchange market, also called the forex market. It is the global marketplace that sets the exchange rate for currencies around the world. It is a decentralized or over-the-counter market for the trading of currencies at their current market price.

    Foreign exchange markets include large international banks, central banks, multinational companies, investment banks, forex dealers, hedge funds, etc. All of these buy, sell, exchange, and make guesses on the relative exchange rates of any two currency combinations.

    Why do we care about exchange rate fluctuations?

    For any international currency transaction, you need to know the exchange rate. So, if the current exchange rate is 1 USD=80 Indian Rupees, this means when you go to India, you would get approx. Rs 80 for 1 USD. Similarly, if an Indian comes to the US, they would have to pay approx. Rs 8000 to get $100. In real life, foreign exchange dealers make a small profit on any foreign exchange transaction.

    USD appreciated against major currencies of the World

    Recently, in the news, you must have heard that the US Dollar has appreciated against major currencies of the world. I found this chart from IMF’s Oct 4, 2022 blog post and it shows the US dollar vs major currencies. You can see how the USD appreciated against the British Pound sterling, Japanese Yen, Indian Rupee, Euro, and many others since the start of 2022.

    The IMF post stated that economic fundamentals are a major factor in the appreciation of the dollar. Rising US interest rates and its more favorable terms-of-trade compared to other countries in Eurozone, UK, Japan and China have caused the US dollar to emerge stronger.

    Don’t worry if this isn’t clear to you yet, I will explain this mechanism in just a bit.

    What factors influence a price of a currency against another currency?

    The answer to this question lies in the fundamental economic concept of excess demand. The price of a currency relative to another currency will go up if there is more demand for it.

    A country’s exchange rate can either Appreciate, which is an increase in the value of the currency, or the exchange rate

    Or

    Depreciate/devalue, which is a decrease in the value of a country’s currency or the exchange rate.

    Below I have a chart from google finance showing a continued appreciation of USD or the depreciation of Indian Rupees. Twenty years ago, the exchange rate for 1 USD was around 45 Rupees. Since then, the demand for USD has been rising and the price of USD relative to the Indian Rupee has been rising. As of Oct 15, 2022, it is 82 Rupees to 1 USD.

    In the graph below, you can see how the intersection of demand and supply determines the price or exchange rate. We will take call point A as the year 2014 when the exchange rate for 1 USD was 65 Indian Rupees, where demand and supply met.

    With a continued increase in demand for USD, the demand curve shifted up to the right. With the same supply, the new intersection happens at point B, at this point the price of 1 USD is 80 Rupees in Oct 2022. Thus, if the demand for a currency is high relative to another currency, its exchange rate will go up. The opposite will happen when the demand for a currency is low relative to another currency.

    What causes a change in the demand for a currency?

    Many factors can influence the currency’s demand and the exchange rate. Let’s understand the most important ones below. Since we are looking at the appreciation of the USD against major currencies, I will use USD as an example to explain it.

    • Relative Interest rates

    When interest rates are higher in a country there are more money inflows in the US. This happens because international investors would invest there to get better returns. As investment happens in the USD, there’s more demand for USD. This causes the USD value or the exchange rate to appreciate.

    • Relative inflation

    A low and stable inflation rate also plays a key role. Many developed countries such as the US, and the UK have had inflation of around 2% in the past. Although this has changed recently after the pandemic and Ukraine war, it is still lower than in many other countries.

    A lot of times more than one factor play a role in influencing the exchange rate

    A low Inflation rate in the U.S. relative to another country, such as India, can cause the US currency to appreciate. Let me explain why this happens. Low inflation in the US will mean US imports become cheaper to India and India will demand more US-made goods. I just want to point out that when India imports from the US, it pays for those in USD. So, increased demand for US imports will lead to increased demand for USD. This will cause its relative value or exchange rate to rise against the Indian rupee. For more than a year US economy has been witnessing high inflation. The reason USD is going strong is because other countries are dealing with even higher inflation.

    • Current account surplus

    A current account is the balance of trade between a country and other countries it does international trade with. It includes all the payments between countries for physical goods, services, interest, and dividends.  A deficit in the current account shows a country’s imports are more than its exports. To cover this deficit, that country will usually borrow capital from other foreign countries. This causes its currency to depreciate.

    • Relative Strength of the economy

    Also, the relative strength of the US in comparison to other developed countries plays a role too.  If the world is worried about other developed countries’ performances such as the UK, EU, and Russia, the U.S. dollar price will rise in the international market.

    • Speculation

    Also, expectation and speculation play a role in determining a currency exchange rate. If more people believe that the value of the U.S. dollar will rise relative to other currencies in the future, they will demand more of the US dollar to sell it later for a profit. This is going to further increase the demand for the U.S. dollar causing an increase in its value.

    • Relative Competitiveness

    If businesses in the US become more competitive relative to the UK, this will also cause an increase in demand for US-made goods causing an appreciation or increase in the value of the U.S. dollar compared to the pound sterling.

    Conclusion

    In the long run, how strong a country’s economy is and how competitive it is relative to its other countries will determine its exchange rate. A technological innovation that leads to higher productivity will strengthen that country in the international market and will lead to an appreciation in its value.

    What has caused exchange rate fluctuations can be hard to pinpoint, as most of the time several factors play the role.

    Clearly, an appreciation in the US dollar has made travel to the UK and other countries much more affordable for the US people. To see who all benefit from the appreciation or depreciation of a currency, stay tuned for my next post.

    Credit: Images from Freepik

  • How does people’s expectation about inflation affect the actual inflation?

    What people like you and me think about inflation directly impacts the actual inflation rate. So, if we think inflation will be high in the coming months, it will most likely be. In this post, I will explain how this phenomenon works.

    If we expect that overall prices are going to rise in the coming months, we may buy more things now, rather than in the future. If a lot of people do that, this increases the demand for goods and services.

    High inflation is directly linked to a higher demand that is not immediately matched by an increase in supply. As a result, firms increase the prices of goods and services when there is more demand. This enables them to make more profit. As a result, we see increased prices passed on to the consumers causing higher inflation.

    On the other hand, if people expect prices to fall in the future, they may delay spending now to get a better deal. This will result in a decrease in demand for goods and services and businesses will end up lowering prices to clear up their stock.

    So, now we understand how inflation expectations affect actual inflation. If you want to know more about inflation and how it is calculated, you can refer to my post here.

    What is the current inflation expectation in the U.S.?

    After suffering from really high inflation close to 8%-9% for over half a year, we foresee some good news. A survey conducted by the Fed reserve bank of New York shows a decrease in these expectations.

    People in the U.S. feel that one and three-year-ahead inflation are now going to be 5.7 % and 2.8 % respectively.

    These are clearly lower than 6.2 % and 3.2 % in June for one and three years ahead inflation rates respectively. In the figure from the Federal Reserve of New York website, you can see how there is a decline in the curve of the expected inflation rate towards the end. This is the survey done in the month of August 2022 about what people think inflation may look like for 1 year and 3 years.

    It shows that people’s expectations are consistent with what the Fed is trying to achieve. By raising interest rates, the Fed is trying to slow down the demand in the U.S. When borrowing becomes expensive, people generally tend to borrow less for things like cars, mortgages, etc.

    In their September 20 meeting, the Fed is most likely going to raise the key federal funds rate by another 75 basis points. The Fed has been raising interest rates to fight the high inflation in the U.S for the last 6 months. Central banks in a lot of other countries fighting inflation have been doing the same.

    To learn more about the role of the central bank, stay tuned for my next post.

  • Did inflation fall to 0% in the US in July?

    Yesterday, in the news, I read President Biden saying the US had 0% inflation in July. The BLS, the official source of inflation numbers, reported no change in the CPI (Consumer price index) from June.

    So did inflation suddenly disappear? Well, it depends on how you measure it.

    Sometimes, the way politicians report some facts could give us misleading conclusions. So, the economist in me had to write something today to help my readers understand it better.

    How do we measure inflation?

    As I said above, the official inflation number in the US comes from the BLS every month. BLS calculates price inflation both monthly and annual.

    If you want to know more about inflation in simple words, you can read my previous posts. I described how we can calculate inflation using some simple examples. I also explained what policy measures the central bank takes to control inflation – my most favorite post.

    So was Biden lying when he said 0% inflation?

    There was indeed no general average price increase from June 2022 compared to July 2022. This meant a 0% monthly inflation.

    However, the year-to-year inflation ending July 2022, was 8.5%. This is still very high, compared to the average US inflation of around 2%. Inflation is the percentage price increase of a basket of goods and services people in the urban United States use. This is of course, over a specific period.

    But, the good news is that it was somewhat less than the June 2022-to-2021 inflation of 9.1%.

    A picture is worth a thousand words

    Here is a chart showing category-wise inflation. The food prices continued to rise. Few others, such as electricity, new vehicles, and shelter also rose.

    The main reason behind 0% monthly inflation was the falling gas prices. It offset the increase in food and shelter indexes. The lower gas prices finally come as a relief to millions of Americans. We have been experiencing a sharp rise in gas prices for a long time and wanted a break.

    Hopefully, Fed’s tight monetary policy will bring inflation down further in the coming months. But, there might be a cost to it- the possibility of a recession. As we say in economics, there is no free lunch. Let’s just hope that even if the R word happens, it is not significant.

  • The jobs market in the US is still going strong

    Two days ago, President Joe Biden proudly posted that the unemployment rate in the US was 3.5% in July. This matched the lowest rate in the last 50 years. He also said that since he started, 10 million jobs have been created in the US economy.

    Praising the fastest-growing job market, Biden mentioned that 528,000 jobs were added in the US in July itself. “Today, we also matched the lowest unemployment rate in America in the last 50 years: 3.5%,” he said.

    The Bureau of Labor Statistics (BLS) in the US publishes data for the unemployment and labor force statistics every month. These are based on the data collected from household surveys and establishment surveys on sample-based estimates of employment.

    I got this Civilian unemployment rate graph from the BLS. You can see that the US unemployment rate is now at its lowest level at 3.5%. This had happened three times before in Sep 2019, Jan 2020, and Feb 2020, when it hit 3.5%.

    But have you ever wondered what is the unemployment rate anyway?

    Well, the unemployment rate is the percentage of people who don’t have a job but can work and have actively looked for a job in the past 4 weeks. This is relative to people in the labor force.

    According to the BLS, The labor force is the sum of employed and unemployed people ages 16 and older at a given period.

    Their recent report about July’s unemployment rate was contrary to what many people would have expected. People were expecting a somewhat slowdown in the job market, but clearly, this hasn’t happened yet. The Fed has been raising interest rates to control inflation. The Fed’s policy aims to cool the overheated economy by reducing overall spending by individuals and businesses.

    So what does a low unemployment rate mean for you?

    If you are looking for work or want a change of job, right now could still be a good time for that. There’s a huge likelihood of you finding it sooner than later and as per your terms. With many employers paying higher salaries, it is a good time to ask for a raise if you think you deserve it.

    When the effects of tightening monetary policy start showing up and we see a reduction in jobs created, it might be a little late to negotiate.

    As always, if you enjoyed reading my post and learned something, please feel free to write your views in the comment section below. Thank you, till we meet again next time!

  • Why did Fed raise interest rates again, making borrowing more expensive?

    Ending their two-day meeting, the Fed (central bank of the US) has once again raised interest rates. The reason for the hike is to control inflation. The United States Congress has given the Fed a dual responsibility – to achieve maximum employment and keep inflation around the rate of 2% over the longer run.

    The average consumer in the US has been feeling the burden of rising prices, especially since the start of this year, esp. in gas, housing (including rental), and food prices. The Consumer Price Index, which measures inflation in the US has been at an elevated level for quite some time. In their press release, as of July 13, 2022, the BLS published inflation at 9.1%.

    How does the interest rate affect inflation?

    Going back to today’s news, let’s understand how the interest rate mechanism works. The FOMC (Federal open markets committee) is responsible for determining the federal funds rate target range. This is the rate at which banks borrow from each other. The Fed doesn’t set this rate, but market forces determine it.

    The reason this rate is very important to us is through its linkages to other rates. This federal funds rate impacts all the other interest rates such as on credit cards, housing, auto, and education loans.

    How much did Fed raise interest rates?

    In today’s meeting, the Federal open market committee decided to raise the target range for the federal funds rate from 2.25% to 2.5%. This increase has moved the Federal funds rate to its highest level since December 2018. During their June 13, 2022 meeting, they increased the target range for the Federal funds rate to be 1.25% – 1.75%. You can see the graph of this rate over time here.

    So how does the Fed steer the federal funds rate?

    It uses “interest on reserves balance” as its main monetary policy tool for that. To understand it better, you can read my article here, which explains this in detail. When the Federal funds rate (borrowing costs of banks) is high, banks will pass on these added costs to their final consumers. These consumers include people like you and me, and businesses.

    In a nutshell

    The main idea behind this repeated increase in the interest rate is that expensive loans will discourage people from spending. When the cost of borrowing (interest rate) is high, general consumers (households) borrow less for a big purchase such as a car or a house. Similarly, businesses also invest less in the expansion of their plant, inventories, machinery, buildings, etc. All of this will reduce the demand for goods and services these businesses make and they will also hire fewer workers. And when the excess (increased) demand is lower, the prices will eventually start falling, which will control high inflation. Thus, interest rate hikes are the Fed’s main tool to control inflation.

    Inflation happens because of strong consumer demand, which supply can’t match. Supply bottlenecks with China during the Covid pandemic, Ukraine war, etc have all contributed to a weaker supply of many essential items we use every day. Since many of the supply chain issues will take a long time to fix, the Fed is trying to control the demand aspect of inflation. By raising interest rates, and making borrowing more expensive, the Fed is hoping to weaken Americans’ willingness to spend money and ultimately bring inflation close to its 2% target level.