Quora Answer: Why Do Other Countries Care about the Federal Reserve Interest Rate?

The following is my answer to a Quora question: “Why do other countries care about the Federal Reserve interest rate?  Is it because central banks mainly hold Treasury bonds?” 

The United States is the largest economy in the world, which makes the US dollar the default reserve currency.  All major international transactions of oil, and other commodities are in this currency.  The Federal Reserve uses monetary policy to manage the US economy, and that affects the global economy. 

When interest rates rise, affected currencies appreciate.  The opposite is also true.  Lowering interest rate spurs economic growth because it makes borrowing cheap.  Increasing rate curbs borrowing, but lowers the rate of inflation.  This has an effect across the world.  There are many currencies which are pegged to the dollar, or have it as a major component of their basket of currencies.  This has a cascading effect on the foreign exchange market, commodities, and the market in general. 

This change in currency rates also has an effect on global credit.  Most major international debt is denominated in the US dollar.  This means countries are borrowing in the IS dollar, but they are issuing local currency.  This means debt can be more expensive or less expensive, depending, affecting their domestic economy.  The state of the domestic economy and the liquidity of their government instruments has a direct correlation with foreign direct investment. 

Banks and financial institutions also borrow from each other, and issue credit.  The cost of borrowing affects the cost of issued letters of credit and loans, which affects domestic and international trade everywhere.  No economy can decouple from this, even pariah states such as North Korea. 

US Treasury bonds are directly connected to interest rates, and the Treasury yield curve is commensurate with domestic interest rates, since this reflects the borrowing of the US government.  The rate of Treasury bonds have a direct effect on the rate of other sovereign bonds.  Their attractiveness is related to their yield in relation to Treasury bond yields.  This effects the global bond market. 

As can be seen, the Federal Reserve interest rates have a profound effect on economies all over the globe, influence borrowing, international trade and foreign investments everywhere.  Countries care about it because there is a direct effect on them.