Janet Yellen, the Fed Queen, announced on Thursday, September 17, that the mother of all interest rates would stay put. No surprise, but does this mean the economy is still in recovery mode?
The Federal Reserve has decided that increasing the federal funds rate at this time would not be the best move. In 2008, the Fed brought down the fed funds rate to 0.25 percent due to the financial crisis in the Great Recession. Seven years later and we’re still at that same rate. What does this all mean?
FKD 101: The Fed
Well, to start off, you need a little rundown of the Fed. My fellow fellow, Emily Pirt, wrote an FKD 101 blog on the Fed, giving you the lowdown. Basically, the Fed is the head honcho of the banking system in the United States and focused on two main things: unemployment and stable prices. The Fed isn’t the government’s puppet, but it does report to Congress on a regular basis. The Federal Open Markets Committee (FOMC) meets about eight times a year. In March, June, and September, it keeps the public in the loop with how they think the economy is doing and what actions they are going to take in regards to monetary policy.
The FOMC, headed by Chairwoman Janet Yellen, have pretty limited but effective tools to use in directing the economy in a comfy, positive trend. They can buy or sell U.S Treasurys and they can set the fed funds rate. The buying and selling of U.S. Treasurys is a way to increase or decrease the money supply. When they sell U.S. Treasuries through “open market operations” this is known as “contractionary monetary policy.” This is a way for them to decrease the amount of money in circulation, because they have some reason to believe the economy is too hot. Ow, Ow! Too hot usually means prices have skyrocketed. The opposite is called “expansionary monetary policy,” where the Fed buys U.S. Treasurys and slides tons of money into circulation. Prices are supposed to go up after this.
Contractionary-Bring prices down
Expansionary-Bring prices up
The other tool in the FOMC’s toolbox is the power to set the fed funds rate. The fed funds rate is the interest rate at which banks, or depository institutions, that are in the Federal Reserve System (which are most of them) loan to each other overnight. The higher the interest rate, the less inclined a bank is to borrow money from another bank and discourages us, the consumers, from borrowing money. At high interest rates, people would rather save and make money on their savings. The lower the rate, banks are more likely to lend out and encourages us, to take advantage of the low rates and take out loans.
Three months into the financial crisis, the Fed dropped the fed funds rate to 0.25 percent. Just to give you some perspective, for seven years before the drop, the rate averaged at 2.20 percent. A couple years leading to the financial crisis, the rate was floating around 4%. The reason behind this drop in the rate was to, like said before, low interest rates means people borrow money.The Fed wants people to borrow because they buy stuff with that borrowed money. Buying stuff means people have jobs to make the stuff. Setting the interest rate low is like spraying WD-40 on the gears of the economic machine that keeps people working and allows the economy to keep rollin’.
So Why Is Yellin Chillin’?
Seven years of .25 percent fed funds rate and still no budge. An increase of the rate would an effect on the financial markets of not only the country, but the world. This would change the how consumers behave in the economy. After seven years unemployment has gone down from 10 percent in October of 2009 to 5.1 percent in August of 2015. So why is Yellin still chillin’ on the rate? Remember the Fed’s dual mandate: unemployment and stable prices?
Inflation is not up to par. Wages and prices across the board have not been increasing at the Fed’s desired rate of 2 percent per year. Yellin, and the FOMC are nervous that an increase in the fed funds rate may reverse the progress they have done so far. In essence, if the rate is increased before the economy is ready, it could throw a wrench in the gears after spraying all that WD-40 on the gears. We’ve seen central banks in other countries jump the gun and recreate the recessions and financial crises that they were trying to get out of.
The cautious silver fox didn’t surprise most with this decision. However, it is disheartening that the faith in our economy to handle a higher rate is just not there.