Business Line: On Federal Reserve’s track

September 30, 2013

Nikhil Kamath explains Federal Reserve and it’s importance on Nifty and Sensex.

Love it or hate it; but you cannot ignore it. That is the Federal Reserve for you. Words like taper, QE, Fed are peppering most stock market conversation these days and are also the perpetrators of huge doses of volatility in recent times. Here is a brief introduction to “The Fed” and how it moves the Sensex and Nifty.

The Federal Reserve or ‘The Fed’ is the central bank of United States, much like the Reserve Bank of India (RBI) tasked to control interest rates, money supply, oversee the banking system, control inflation and so on.

The Federal Open Market Commission (FOMC) is the committee of the Fed that meets around eight times in a year to take monetary decisions on — reserve requirement (how much a bank to hold in reserves), discount rate (the interest rate charged by the Fed to commercial banks and other depository institutions on loans they receive from the Federal Reserve Bank’s lending facility), open market operations (used by the Fed to purchase US government bonds in the open market as a means to adjust the Federal Funds Rate, which in turn controls the inter-banking lending rates) and other decisions.

Most of these have lost relevance post-2009 when Quantitative Easing came into play.

Quantitative Easing (QE): 

Usually central banks try to increase lending activity indirectly by cutting interest rates. Lower interest rates encourage people to spend and not save which, in turn, boosts the economy. But when the rates were already close to zero by 2009 and could go no lower, the Fed decided to print and start pumping money into the economy directly, which can also be called QE.

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Nithin Kamath

CEO @ Zerodha and partnering startups through Rainmatter to help grow and improve the capital market ecosystem in India. Love playing poker, basketball, and guitar. “You don't have to be a hero to accomplish great things---to compete. You can just be an ordinary chap, sufficiently motivated to reach challenging goals.” - Edmund Hillary

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  1. Alok says:

    You said Fed and RBI control inflation by increasing intrest rate, How it possible ? When every one has good earning source , like NAREGA etc, and salary increasing every year, value of corp rising so Kisaan also earn good money. I mean the power of purchasing increasing , and the shortage of commodity, so that price increasing.

    Please let me know how intrest rate will control the inflation ? Thanks in advance.

    • Nithin Kamath says:

      Alok,

      Across the world, when interest rates go up it would mean lesser people borrowing money, lesser people borrowing means lesser being spent on goods and this would in turn mean a reduction of the prices of goods because of lesser demand, hence controlling inflation.

      Typically central banks have used this ploy to increase interest rates whenever they want the inflation rates to go lower.

      Cheers,

    • Alok says:

      So its mean across the world, people borrowing money for goods, but inflation hit in India only if food item rate will increase, and no one borrowing money for foods and no body lending also.

    • Nithin Kamath says:

      Alok,

      Inflation in India is not only related to food, but everything else also. Inflation in India is also affected by the depreciation of our currency.

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