The Federal Funds Rate, the
interest rate at which banks with balances at the Federal Reserve borrow from
one another, is one of the most important interest markers in the U.S. economy.
It serves as a point of reference for other interest rates and has profound
influence upon overall economic activity, helping to both stimulate the economy
and control inflationary pressures. When the Fed wishes to spur economic
growth, it reduces interest rates, when it seeks to dampen economic activity,
the inverse.
The current target for short-term
interest rates is between 0% and 0.25% as set by the Federal Reserve.
Responding to the 2008 financial crisis, the Fed swiftly pivoted to ratchet
down the Federal Funds Rate to near zero, seeking to bring rates as low as
possible to keep the economy afloat as well as to help banks earn a higher
“spread” between borrowing and lending rates. Since 2008, the Fed has kept
rates in this 0-0.25% range, believing the U.S. economy incapable of sustaining
positive growth without continued central bank stimulus.
In
their article, Peter Schroeder and Vicki Needham suggest that the days of near-zero
interest rates may soon be a thing of the past. Amid a recovering yet still
complicated economy, Federal Reserve Chairwoman Janet Yellen must determine not
if she should raise interest rates,
but rather when. On one hand, we can
see that the economy has clearly improved: more jobs have been created than
were lost in the recession and unemployment rates have dropped from nearly 10%
to 6.2%. It should be cautiously noted, however, that it took five years to
reach this point and that the labor market is still not fully recovered.
When
it does finally decide to raise interest rates, the Fed will likely take a
slow, deliberate approach. Most economists predict the initial increase to
occur mid-2015, with a 30-month window between the first and last rate hike. I
believe that a near-zero interest rate policy should be judiciously implemented
in times of economic hardship. If the Fed considers the economy to be fully
recovered, I believe it should raise the interest rate as soon as possible. I
am interested in the various pros and cons associated with the speed at which
interest rates are raised, why the Fed will likely take a slower approach and
the reasoning behind it.
In a slowly growing economy where wages are not increasing as the prices of goods and services increase, raising the interest rates might be detrimental to the economy. Lower interest rates enable economic growth because there is more spending and borrowing. on the other hand inflation will be inevitable if interest rates remain low. The best solution will depend on the type of economy we have at the time. Raising interest rates in a slowly growing economy will damage the economy in the long run as businesses will borrow and spend less.
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