WASHINGTON ― The Federal Reserve raised its benchmark interest rate on Wednesday, a sign of its continued confidence in the economy in the wake of President Donald Trump’s inauguration.
The move, which reflects the Fed’s satisfaction with job growth and its mounting concern about inflation, is the first rate hike since Trump took office.
The central bank’s Federal Open Market Committee increased the target federal funds rate — what banks charge one another for overnight lending — by 0.25 percentage points, to a range of 0.75 percent to 1.0 percent.
“Our decision to make another gradual reduction in the amount of policy accommodation reflects the economy’s continued progress toward the employment and price stability objectives assigned to us by law,” Federal Reserve Board Chair Janet Yellen said at a Wednesday press conference following the announcement.
One member of the FOMC dissented from the decision to raise the rate. Neel Kashkari, president of the Federal Reserve Bank of Minneapolis, voted to leave the target federal funds rate unchanged. There was no explanation for his dissent in the Fed’s press materials.
The Federal Reserve has a dual mandate from Congress: to maximize employment, and to keep prices stable. The Fed raises the federal funds rate to tame inflation by putting downward pressure on job market growth.
When this form of interbank lending becomes more expensive, creditors tend to respond by increasing interest rates on home loans, auto loans, student loans, credit cards and a variety of other types of debt. As a result, the Fed’s quarter-percentage-point increase will likely squeeze borrowers and consumers, while upping the earnings of lenders and savers who rely on interest-bearing investments.
Although Wednesday’s rate hike is just the third increase since the Fed lowered the influential rate to zero in December 2008, it is the second hike since December 2016, suggesting the Fed is finally accelerating its efforts to raise borrowing costs. Prior to December, the central bank had gone a year without raising the rate after global economic headwinds gave it caution.
“Looking ahead, we expect that job conditions will strengthen somewhat further... and [we expect] overall inflation to stabilize around 2 percent over the next couple of years in line with our longer-run objective,” Yellen said Wednesday.
“The simple message is the economy is doing well,” she added later, when asked what message she would like consumers to take away from the rate hike decision. “We have confidence in the robustness of the economy and its resilience to shocks.”
However, Dean Baker, co-director of the liberal Center for Economic and Policy Research, argued that it is still too soon to raise the benchmark rate and risk putting the brakes on job growth.
“It’s the wrong move,” Baker said on Tuesday. “It’s based on some wrong views about the economy, particularly that we’re closer to full employment than I think we are. But a quarter-point doesn’t have a huge impact on the economy.”
Baker is one of many economists, most of them progressive, who believe the low headline unemployment rate masks underemployment and fails to convey the lower pay of the new jobs being created.
The national unemployment rate dropped to 4.7 percent in February as the economy created 235,000 jobs.
But the official unemployment rate fails to account for people working part-time involuntarily, or people who have given up looking for work altogether. A broader metric that counts those workers as unemployed shows a jobless rate of 9.2 percent.
In addition, many American workers are settling for lower-paying work. Sixty percent of the net new jobs created between December 2007 and December 2016 were in retail, hospitality and other service sectors that tend to pay less and provide fewer work hours than other sectors, according to an analysis by Dan Alpert, founder of Westwood Capital and a fellow at the Century Foundation.
“It’s based on some wrong views about the economy, particularly that we’re closer to full employment than I think we are. But a quarter-point doesn’t have a huge impact on the economy.”
- Dean Baker, co-director, Center for Economic and Policy Research
Meanwhile, a measure of price inflation that excludes volatile food and energy prices rose 1.7 percent in the 12-month period ending in January ― still below the Fed’s 2-percent inflation target. Baker and like-minded economists prefer the risk of exceeding that target to the risk of prematurely depressing the job market.
Stephanie Kelton, an economist at the University of Missouri-Kansas City and an economic adviser to the presidential campaign of Sen. Bernie Sanders (I-Vt.), agrees with Baker that the economy is still employing fewer people than it could.
But Kelton argues that there are limits to what the Fed should be expected to do to make up for the federal government’s failure to boost growth through public spending. She understands what she believes is the Fed’s desire to raise rates now so as not to deprive itself of the ability to stimulate the economy later.
Fed officials “want some space,” Kelton said. “They want to be able to get away from zero with enough distance so when the next recession inevitably comes, there’s some room to move down.”
Economic observers now await the White House’s reaction to the Fed’s announcement. During the 2016 presidential campaign, Trump was critical of the Fed for failing to raise interest rates ahead of the November election, accusing Yellen of artificially buoying the economy to benefit the incumbent Democrats.
But as Trump prepares a major package of tax cuts and a large infrastructure plan ― which even some of his critics believe could boost the economy further ― he could soon be on a collision course with the Fed for doing exactly what he claimed it should have done under President Barack Obama: raise interest rates.
Any of Trump’s policies that create more jobs would likely prompt the Fed to increase the funds rate more rapidly. The contractionary impact of those hikes could offset any expansionary effect of Trump’s agenda.
Yellen insisted on Wednesday that Fed officials were not basing their decisions to raise rates around the expected impact of Trump’s policies. She also acknowledged meeting Trump briefly, and speaking with Treasury Secretary Steve Mnuchin on more than one occasion.
Try as Yellen might to avoid it, however, she had to field questions about a potential showdown with Trump. The Fed’s policymakers predict that economic growth will reach 2.1 percent in 2018 before leveling off at 1.8 percent in 2020 and beyond.
Trump has promised that his policies will generate 4 percent economic growth, and claims they could even spur 5 percent growth rates.
When asked about the disparate estimates, Yellen denied that Fed officials’ more conservative growth projection reflected a possible “point of conflict” with the president ― so long as inflation remains within the Fed’s target range, that is.
“I don’t believe it is a point of conflict. We would certainly welcome stronger economic growth in the context of price stability,” Yellen said.
As with many issues, Trump’s stance on the Fed has not been entirely consistent, and it’s possible he could embrace his old ideas if circumstances warrant it. Before Trump began arguing that Yellen was using low rates to inflate an economic bubble for political reasons, he had expressed support for her policies, claiming the low rates were good for U.S. exports.
Should the Fed respond to Trump with higher rates, and should Trump challenge the Federal Reserve for prioritizing concerns about inflation over allowing job growth to proceed unencumbered, he might find unlikely allies in progressive economists who have long taken issue with the Fed’s priorities. But that’s far from a sure thing.
“At this point, I won’t place bets on that. I guess we’ll find out soon enough,” Baker said.
This story has been updated with remarks from Yellen and additional details about the Fed’s decision.
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