The US Federal Reserve and the Impact of Raising the Interest Rate Domestically

Last Wednesday, the U.S. Federal Reserve raised the interest rate by 50 basis points (0.5%) on loans and deposits, the largest increase in 22 years. The Fed did so in order to reduce liquidity in the market and control inflation rates, which reached more than 8.5%, the highest in 40 years.

Locally, and following the Fed’s rate hike, the Central Bank of Jordan raised the interest rate by 50 points. This decision has both positive effects and negative ones as well.

Its positive effects can be summed up by the fact that this will contribute to the stability of the dinar and the preservation of investments, especially since the interest margin for deposits between Jordan and the Gulf is around 1.5%. Raising the interest rate by 0.5% will maintain this margin and the balances of individuals and institutions across the Gulf in Jordanian banks, especially since all of the central banks in the Gulf raised their interest rates as well. It will also necessarily attract other investments from those countries.

Also, raising the interest rate will control inflation, which locally reached more than 2.2% and is expected to reach more than 3% before the end of this year. Raising the interest rate by 50 points has a positive and direct impact on inflation.

Yes, there will be an impact on economic growth in the short term, but in the medium and long term it will be an attractive factor, especially since the pegged price of the dinar against the dollar, in force since 1995, has played an important and significant role in the stability of Jordanian monetary policy and in attracting investments.

In order for growth not to be affected, fiscal policy will require some adjustments; this is the responsibility of governments, in order to avoid the economy falling into so-called stagflation and deflation.

Also, one of the positive effects of raising interest rates is that the central bank loan allocated to production sectors, including industry, will not be affected and will remain within 2%; this is most important for the continuation of production.

As for the negative effects of this decision, they will first be borne by the treasury, and then by institutions and individuals.

The negative impact on the treasury will be the high interest rates on past and future loan installments that the government pays to donor institutions and local banks. The amount that the government intends to borrow this year will be at higher interest rates, and this will result in a larger deficit than was expected in the 2022 budget.

As for the impact of the higher interest rates on individuals and institutions, it is expected that these rates will rise at least 0.5% to 1%. This will requires some flexibility on the part of the banks so that the number of defaulters does not increase, especially since individual loans cannot bear more rises. It is hoped that local banks will bear part of these rises under these delicate economic circumstance.

In conclusion, governments must find quick solutions and reforms, as directed by His Majesty the King in the economic workshop, in the form of fiscal policy tools to support citizens and the various economic sectors for fear of deflation.