The Federal Reserve has decided to raise its benchmark funds rate from 0.75 percent to one percent. Economists and analysts expected the move based on Chairperson Janet Yellen’s previous comments as well as data indicating that the economy is near full employment while inflation is close to the two percent target. While inflation had not yet become a concern, Yellen is hoping to avoid a scenario where low interest rates fuel rapid inflation and price increases in the future. The Fed now expects inflation to remain constant at two percent due to the change.
Last December, the Fed indicated that it planned on a total of 0.75 percent increase in interest rates for 2017, meaning two further hikes are expected. Not all of the board members, however, agreed with the timing as Federal Reserve Bank of Minneapolis President Neel Kashkari dissented on the grounds that the Fed could increase rates later.
The move comes as unemployment remains at 4.7 percent, signaling that the economy is near full employment, and GDP growth nears two percent. While official unemployment is low, the percentage of workers underemployed has yet to return to pre-recession levels, indicating there is room to grow in the labor market. Headline prices rose by the largest amount since 2012, giving credence to the notion that runaway prices were at risk if the Fed failed to act.
The Fed’s change will have wide implications for the economy. Raising interest rates lowers the likelihood of inflation, which prevents prices from rising dramatically as they threaten to do based on the most recent headline price data. Nominal wage increases, however, become less likely since there is less need to offset rising prices with more income. The U.S. dollar will strengthen due to less demand, making international travel and imports more affordable. From a financial perspective, impacts are always mixed. Rising interest rates make borrowing money more expensive but increase yields from bonds and savings accounts. Ultimately, the Fed felt the need to make easy money at low interest rates less available to prevent runaway inflation from triggering a future crash.
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