To the surprise of basically nobody at this point, the Federal Reserve Board announced today that it was raising a key interest rate, the first time the Board has raised rates in nine and a half years:
WASHINGTON — The Federal Reserve said on Wednesday that it would raise short-term interest rates for the first time since the financial crisis struck, a vote of confidence in the strength of the American economy at a time when much of the rest of the global economy is struggling.
The widely anticipated decision, a milestone in the Fed’s postcrisis stimulus campaign, ends a seven-year period in which the Fed held short-term rates near zero. Even as it raises its benchmark interest rate by 0.25 percentage points, to a range of 0.25 to 0.5 percent, however, the Fed emphasized subsequent increases would come slowly.
The decision to raise rates “recognizes the considerable progress that has been made toward restoring jobs, raising incomes and easing the economic hardships that have been endured by millions of ordinary Americans,” the Fed’s chairwoman, Janet L. Yellen, said at a news conference after the decision was announced.
Interest rates on mortgages and other kinds of loans, and on savings accounts and other kinds of investments, are likely to remain low by historical standards for years to come.
Moving to raise rates is the most important and riskiest decision the Fed has made under the leadership of Ms. Yellen, the Fed’s chairwoman since early 2014.
Every other developed nation that has raised rates since the end of the financial crisis has been forced to backtrack as economic conditions proved unable to handle higher rates. There are also signs of strain in some financial markets as investors dump high-yield junk bonds and pull money from developing markets.
The decision to raise rates was supported by all 10 voting members of the Federal Open Market Committee. They agreed on the move despite concern expressed in recent months by three of those officials that the economy might not be ready for higher rates, a view shared by some outside economists and by Democrats who argue the Fed is prematurely curtailing job and wage growth.
The Fed’s announcement cited the strength of job growth, and the broader backdrop of a moderate-but-steady economic expansion, as evidence that the economy no longer needed quite as much help from ultralow borrowing costs.
Fed officials predicted in a set of forecasts also published Wednesday that they would raise interest rates by about one percentage point a year over the next three years, reaching 3.3 percent by 2019.
The Fed said that beginning on Thursday, it would seek to keep short-term interest rates in its new range. To set the new baseline, the Fed said it would pay banks an interest rate of 0.5 percent on unused money, and it would borrow up to $2 trillion from other financial firms at a rate of 0.25 percent. Those measures were stronger than markets had expected, reflecting the Fed’s determination.
Even as the Fed said it would raise rates, it released a set of updated economic projections from its senior officials underscoring that they expect the economy to grow slowly in coming years. The officials predicted, on average, that the economy would expand by 2.4 percent next year and that the unemployment rate would reach a new low of 4.7 percent.
But they expected somewhat slower growth in subsequent years. And even as joblessness remains low, they predicted that inflation would rise only gradually to the 2 percent annual pace the Fed regards as most healthy.
Most officials predicted the Fed would once again miss its 2 percent inflation target next year.
Ms. Yellen herself posed the question in her statement, “With inflation currently still low, why is the committee raising the federal funds rate target?”
She said that inflation was being suppressed temporarily by factors including lower oil prices and that it would rise as job growth continued. She added that the Fed needed to act now because monetary policy influences economic conditions gradually.
If the Fed waited to raise rates, Ms. Yellen said, “We would end up having to tighten policy relatively abruptly at some point.” She continued, “Such an abrupt tightening could increase the risk of pushing the economy into recession.”
Looking ahead, the rate at which the Fed tightens its monetary reins will be the central question confronting Ms. Yellen and her colleagues as the six-and-a-half-year-old economic expansion unfolds in unpredictable ways. The challenges will be heightened even more by the fact that 2016 is a presidential election year.
The unemployment rate has fallen to 5 percent, a level historically consistent with a healthy economy — and is the primary reason the Fed has decided to act. Inflation, however, remains quite weak, indicating that the economy remains weak, too.
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Critics of the Fed’s decision argue that the unemployment data is misleading. The share of adults neither working nor looking for work rose sharply during the recession. Those adults are not counted in the unemployment rate, but some may resume looking for work as the economy improves.
“Our job recovery remains incomplete,” Representative John Conyers, a Michigan Democrat, wrote earlier this week. He has introduced legislation instructing the Fed to aim for an unemployment rate of 4 percent, well below the current rate. “The Fed should not slow job creation and wage growth absent clear evidence of inflation,” he said.
Some analysts said they expected problems in the auto market, where cheap loans have spurred booming sales. While housing sales remain well below prerecession levels, car sales have climbed to record heights in recent years. “It will hurt borrowers and it will hurt the real economy because that’s what’s driving the auto industry right now,” said William Spriggs, the chief economist at the A.F.L.-C.I.O.
Still, while rates on mortgages and other kinds of loans tend to rise with the Fed’s benchmark rate, the relationship is not mechanical. During the housing boom, mortgage rates declined even as the Fed raised short-term rates because of increased foreign investment. That pattern could recur if investors once again conclude the United States is a better investment than other parts of the world.
The era of minimal returns on savings also won’t end soon. Berkley Bank in Englewood, Colo., currently offers an interest rate of 0.50 percent on a one-year certificate of deposit. Brandon Berkley, the bank’s president, said the Fed’s rate increases eventually would translate into higher rates for his depositors and borrowers, but he said the bank might not start raising rates immediately.
As The Washington Post notes, this is the first time the Fed has raised rates since July 2006, when George W. Bush was President, Republicans still controlled Congress as they had since the 1994 elections, and the St. Louis Cardinals were on their way to winning their first World Series since 1982.
Based on how events have unfolded over the past year, this move doesn’t really come as a surprise and, indeed, most investors and others had already priced-in the assumption that we’d get an interest rate hike before the end of the year For the better part of this year, the Federal Reserve has been making clear that they intended to raise interest rates at some point assuming that the economic data justified it. Given the fact that rates were at historically low rates in the wake of the rate cuts that the board had put in place to attempt to deal with the impact of the Great Recession, that the economy has been in recovery, albeit a not entirely strong recovery, since mid-2009, that even the low level of inflation we have now meant that some rates were effectively zero if not in a negative state, and that rates had not been raised since George W, Bush was President, it was seemingly inevitable that there would be an increase at some point. The only question has been when it would happen. Initially, it appeared that we’d see the increase after the board’s September meeting, but a number of factor combined to cause them to step back from the bring. Those factors included economic data that showed that growth was slow, followed by a market panic in China that spread around the world rather quickly, Citing these and other factors, the September meeting ended with the board deciding to delay a rate increase, a step it took again again in October. In the weeks since then, though, various comments from the board, along with stronger economic data such as the October jobs report, signs that third quarter economic growth was stronger than expected based on the most recent revision, and a fairly decent November Jobs Report, made it clear that we’d see a modest rate increase after the conclusion of this week’s meeting.
All that being said, as the article linked above notes, the Federal Reserve is stepping back into uncharted territory with this rate increase and it’s unclear what this will mean going forward. Even though this is a modest rate increase, it’s comparative impact on the economy going forward could be significant when the rate increase makes its way to increases in rates for mortgages, business loans, car loans, and consumer debt. If the Fed has miscalculated and the economy isn’t as strong as they believe then it could be a problem for the economy going forward, something that may not be apparent until well into the New Year. At that point, the condition of the economy is likely to start becoming the important factor in the races for President, Congress, and the Senate that it has always been, and a slowing or weak economy could end up being problem for Democratic candidates in close races. On the other hand, if the increase helps keep the economy moving forward without overheating then it could undermine the Republican argument that the economy is weaker than it appears based on economic data alone. At some point, the Fed may then be forced to act again, but the fact that Federal Reserve Board Chairwoman Janet Yellin has made clear that any future increases would come at a gradual basis would suggest that it won’t happen any time soon. The more important question for Yellin, though, may be whether the board will have to consider backtracking on its increase as other central banks around the world have been forced to over the course of the past several years. We won’t know the answer to that question, though, until we know what impact the increase will have on the economy, and that’s something we can’t know intuitively.
Whatever happens, the Fed has taken a step it hasn’t taken in nearly a decade, and that alone is significant news.
