How Fed rate cuts affect the global economy

The Federal Reserve’s interest rate decisions can influence the trajectory of the U.S. economy.

“The U.S. economy’s stature is one of the key drivers of the importance of the Fed,” said Gregory Daco, chief economist at EY-Parthenon. “The [U.S.] economy remains one of the largest economies in the world, and certainly of late, one of the ones that’s been fastest growing.”

At its September meeting, the Federal Open Market Committee, decided to reduce the target range of its widely impactful federal funds rate. Changes to the Fed’s interest rate can influence the cost of loan products such as mortgages and the value of cash, bonds and stocks.

The Fed’s decision to unwind its most recent economic tightening cycle is expected to be felt around the world. By August 2024, annual inflation was 5.9% globally, according to the International Monetary Fund. The group also reported that inflation was closer to 2.6% on average across advanced economies like the United States.

The Federal Reserve’s decision to cut interest rate comes after months of shaky labor market data in the U.S. The unemployment rate stood at 4.2% in August 2024 with 7.1 million Americans without work, little changed from recent months. But the jobs picture had darkened notably from a year ago, when unemployment was 3.8%, with 6.3 million Americans looking for work.

The central banks of advanced economies around the world hiked interest rates to ward off a global bout of inflation. Economists have noted that the simultaneous tightening of conditions across borders could amplify their effects. The European Central Bank also has reduced its policy rate twice in 2024. Global GDP growth is expected to be 3.2% in 2024 and 3.3% in 2025 according to the IMF.  

“The actions of the Federal Reserve Board they’re not just limited to the U.S. They have an implication, a spillover effect in other parts of the world also,” said Reena Aggarwal, director of Georgetown University’s Psaros Center for financial markets and policy. 

Fed decisions can also impact foreign exchange markets given their effect on the value of U.S. dollars, the global reserve currency.

“Emerging markets are impacted because a lot of their borrowing is in dollars. And so they’ve got to repay the interest and the principal in dollars. And if interest rates are changing in the U.S., all the cost of borrowing is changing,” said Aggarwal in an interview with CNBC.

Other countries have attempted to increase the profile of their currencies with mixed results. Most notably, the People’s Bank of China has established its own international monetary system based on China’s yuan, or renminbi. Economists at the Fed write that China’s central bank has managed the value of the yuan to help the country achieve its goals on trade. China has also established its own network of swap lines to rival the systems offered by central banks like the Federal Reserve and European Central Bank.

“A lot of the [electric vehicles] that we see coming out of China is a direct result of the fact that China has become debt saturated and can’t use its previous growth model to just increase investment,” said Freya Beamish, chief economist at TS Lombard. “If they’re following this growth model, then they have to rely more on exports. At the same time, they want to internationalize the renminbi,” Beamish told CNBC.

The yuan accounted for 4.3% of payments made globally in 2023, according to the Federal Reserve. The U.S. central bank notes that while that share is rising, it’s far behind the use of dollars (47%) or euros (23%).

Watch the video above to learn more about how the Fed’s decisions impact the global economy