Dr. Mohamed Abdul-Sattar Jaradat

Dr. Mohamed Abdul-Sattar Jaradat

On November 7, 2024, the Federal Reserve (Fed) made a strategic decision to reduce the federal funds rate by 25 basis points, bringing it to a range of 4.5%–4.75%. This monetary policy move comes as part of the Fed’s efforts to stimulate economic activity amid slower growth and stable inflation in the U.S. economy. Given Jordan’s pegged exchange rate to the U.S. dollar, this policy shift will inevitably reverberate through the Jordanian economy, influencing both monetary policy decisions and broader macroeconomic conditions. This article delves into the economic impact of the Fed’s decision on Jordan, the subsequent response of the Central Bank of Jordan (CBJ), and the potential consequences on key economic variables such as growth, inflation, capital flows, and currency stability.

1.The Fed’s Rate Cut: Rationale and Economic Intent

The Fed’s decision to lower interest rates follows a period of heightened uncertainty in the global economy, compounded by inflationary pressures and slower economic expansion. The primary objective of this rate cut is to reduce the cost of borrowing, thereby stimulating investment and consumption. The Fed’s policy stance is designed to bolster economic growth, ensure liquidity in financial markets, and prevent a slowdown in job creation. This move is also aimed at keeping inflation within the target range, signaling the Fed’s commitment to supporting the economy without risking a further deceleration.

2.Transmission Mechanisms to the Jordanian Economy

As a result of Jordan’s currency peg to the U.S. dollar, the effects of the Fed’s interest rate decisions are transmitted directly into Jordan’s monetary framework. The Central Bank of Jordan (CBJ), in an effort to maintain exchange rate stability, typically aligns its policy stance with that of the Fed to avoid discrepancies in interest rates between the Jordanian dinar and the U.S. dollar. If the CBJ does not mirror the Fed’s rate cut, the yield on dinar-denominated assets may become less attractive compared to U.S. dollar assets, which could lead to capital outflows, exerting downward pressure on the Jordanian dinar.

3.Impact on Economic Growth and Investment

A reduction in interest rates is a conventional tool for stimulating economic activity, particularly in capital-intensive sectors. In Jordan, where economic growth has been moderate, lower borrowing costs could encourage domestic investment in sectors such as infrastructure, real estate, and manufacturing. Lower rates could also enhance consumer spending by reducing financing costs for household debt. Consequently, this could lead to a boost in aggregate demand, which may support GDP growth in the short to medium term. However, the effectiveness of this policy is contingent on the overall health of the global and regional economies, including geopolitical risks and domestic fiscal constraints.

4.Inflationary Pressures and Liquidity Dynamics

While the rate cut aims to stimulate economic activity, it could also contribute to increased inflationary pressures. A reduction in interest rates typically leads to an expansion of the money supply as borrowing becomes cheaper, which can result in higher demand for goods and services. In the case of Jordan, where inflation has historically been influenced by both domestic and external factors, the increased liquidity could exacerbate price levels, particularly in non-tradable sectors. As the demand-pull inflation effect gains traction, the CBJ may need to carefully calibrate its monetary policy to manage inflationary expectations and avoid overheating the economy.

5.Capital Flows and the Attractiveness of the Jordanian Dinar

One of the key risks arising from the Fed’s rate cut is its potential impact on capital flows. With the dinar pegged to the dollar, investors’ perceptions of the relative attractiveness of U.S. dollar assets versus Jordanian dinar-denominated assets become critical. If the CBJ does not adjust its interest rates in tandem with the Fed, the yield differential between U.S. dollar and Jordanian dinar assets may widen, prompting investors to seek higher returns elsewhere. This shift could lead to a reduction in foreign direct investment (FDI) inflows, as well as portfolio investment, further straining Jordan’s balance of payments and foreign reserves.

6.The Central Bank of Jordan’s Response: Monetary Policy Tools and Adjustments

The CBJ’s primary objective in response to the Fed’s rate cut will be to ensure that the Jordanian dinar remains stable while promoting domestic economic growth. To achieve this, the CBJ may adjust its benchmark interest rates, engage in liquidity management operations, or employ other tools such as foreign exchange interventions to stabilize the dinar. Additionally, the CBJ may monitor the domestic credit environment closely to prevent excessive lending that could lead to financial instability or asset bubbles. A prudent and data-driven approach will be crucial in maintaining macroeconomic stability and safeguarding Jordan’s financial system.

Conclusion:
The Fed’s decision to lower interest rates has significant implications for Jordan’s economy, especially given the country’s currency peg to the U.S. dollar. While the move aims to stimulate U.S. economic growth, the Central Bank of Jordan faces the challenge of balancing domestic growth objectives with maintaining price stability and ensuring the attractiveness of the Jordanian dinar. By carefully managing its monetary policy and responding to both external and internal economic signals, the CBJ can help mitigate potential risks associated with inflation and capital outflows, thus supporting long-term economic stability. However, the success of these efforts will depend on the global economic environment, regional geopolitical conditions, and the ability of local markets to absorb the increased liquidity without triggering destabilizing inflation.