POLITICS
12/14/2016 02:02 pm ET Updated Dec 14, 2016

Federal Reserve Raises Key Interest Rate For Second Time Since The Financial Crisis

The move is likely to hit consumers and small businesses in their bank accounts.

WASHINGTON ― The Federal Reserve raised its benchmark interest rate on Wednesday, a sign of growing confidence in the economy that is likely to pinch consumers and businesses ― and provide a modest boost to lenders and savers.

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 point, to a range of 0.5 percent to 0.75 percent.

Banks use the federal funds rate as a benchmark for interest rates they charge on other forms of credit ― from auto loans to some housing loans ― giving the rate deep economic influence.

Increasing the benchmark rate will probably raise the cost of borrowing for Americans with outstanding loans, whether they are homeowners or operators of small businesses. At the same time, higher interest rates are likely to fatten the profits of banks that lend to these borrowers, and increase the returns of savers, including retirees who depend on interest-bearing bank accounts.

The Fed raises the key rate to tame inflation by putting downward pressure on job market growth. Ensuring price stability is one of the central bank’s two congressionally mandated missions, along with maximizing employment.

“My colleagues and I are recognizing the considerable progress the economy has made toward our dual objectives of maximum employment and price stability,” Federal Reserve Chairwoman Janet Yellen said at a press conference following the announcement of the interest rate increase.

Federal Reserve chairwoman Janet Yellen speaks during a press conference following the Fed's interest rate announcement in Wa
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Federal Reserve chairwoman Janet Yellen speaks during a press conference following the Fed's interest rate announcement in Washington, DC on Dec. 14, 2016.

Wednesday’s move was only the second increase in the federal funds rate since the 2008 financial crisis. The slow pace of interest rate increases reflects the depth and longevity of the Great Recession that followed. 

“The Fed thinks the economy is pretty healthy. They are nudging rates a little bit back to normal, but they are still a long way from normal,” said Joseph Gagnon, a senior fellow at the Peterson Institute for International Economics and a former top economist at the Federal Reserve Board of Governors.

At the time of the previous rate hike in December 2015, the median prediction of the 17 Federal Reserve Board governors and regional Federal Reserve bank presidents was that the federal funds rate would reach 1.4 percent by the end of 2016.

Instead, sluggish economic growth in the first half of 2016, stubbornly low inflation and perhaps the specter of being seen as influencing the November election, prompted the Fed to wait an entire year before raising the rate again.  

The official unemployment rate is now 4.6 percent, which Yellen emphasized on Wednesday is the lowest it has been since before the recession in 2007. Yellen also noted that a measure of prices that filters out the volatile cost of food and energy grew 1.7 percent in the 12-month period ending in October. 

A version of that metric that many experts consider more exact rose only 1.5 percent over that same period.

That’s still significantly lower than the Fed’s 2-percent inflation target.

Gagnon said he believes the Fed wants to begin increasing the benchmark rate before the economy reaches the inflation target to ensure the transition is gradual. 

“We are coming in for a soft landing, which is what they want,” he said. “They don’t want to hit the ground too fast.”  

Other, mostly progressive, economists argue that the low official unemployment rate masks weakness in the job market that has limited wage growth and in turn kept inflation unexpectedly low.

Some 6.4 million Americans work part time because they cannot find full-time work, according to an Economic Policy Institute study released this month.

In a recent blog post arguing against a rate hike, Elise Gould, a labor economist at Economic Policy Institute, noted that pre-inflation wage growth remains significantly lower than it was before the recession.

“There is good reason to think the U.S. economy is still a ways from maximum employment,” said Andrew Levin, an economist at Dartmouth College and a former senior adviser to the Federal Reserve Board of Governors.

Levin said he is less concerned about an individual rate hike right now than he is about the Fed not clearly communicating the criteria it is using to raise rates over the coming months. That is especially concerning because of what Levin considers lackluster economic indicators.

“The strategy they are following right now is very opaque and it’s not clearly tied to the current [below-target] inflation or shortfall of employment from the full employment level,” Levin said.

“Why are they tightening today? Do we have an answer to that question really?” he added.

This post has been updated with comments from Yellen. 

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