Why the Fed Has Not Raised Rates
April 27, 2015
(Image: The Federal Open Market Committee meeting to discuss rate changes during Fed Chair Ben Bernanke’s tenure. Source: Reuters)
An increase in Fed interest rates would have several impacts on the domestic and global economy. If rates are raised, spending and inflation will go down and unemployment will go up. (For more, see our Monetary Policy Primer.) Also, an increase in rates will create an increase in global demand for the U.S. dollar in money markets. The higher the rates, the more people will want to invest in the form of U.S. dollars because those investments offer a higher return (US CDs, bonds, etc.). This causes the value of the dollar to rise, making U.S. goods more expensive to purchase and decreasing GDP.
At this point in time, with European and Asian central banks are undertaking policies of monetary expansion, and with mediocre unemployment rates here at home, the Fed could not raise interest rates without doing harm to the domestic economy. Unemployment has remained at 5.5 percent the last two months, numbers higher than initial Fed projections. An increase in interest rates would increase this number over the next few years, contradicting with the Fed’s aim of lowering unemployment. Also, the rates increase would slow GDP growth and hurt U.S. manufacturers. An increase in interest rates is a tool for tightening monetary policy and curbing abnormal economic expansion. However, at this time, the United States economy is not experiencing the type of expansion that would call for contraction. First quarter economic expansion was poor, inflation is well below the 2 percent target rate, unemployment is not near the desired 4 percent rate, and the dollar is relatively strong compared to foreign currencies.
There has been much discussion on when the Fed will raise rates. Back in October, the projections were for spring 2015. Because growth did not match projections, many economists are now looking to December 2015 for rate increases. On April 16, Fed Vice Chairman Stanley Fischer made it clear what the Fed would be looking for while considering raising rates: “We’d like to see the economy beginning to grow again and grow at a decent rate, and we’d like to see unemployment continue to come down and some signs that inflation is…heading toward the 2% target.” For this December, Fed projections aim for an unemployment rate of 5.2 percent, GDP growth of 2.6-3 percent, and inflation between 1 and 1.6 percent. FOMC will be studying these economic statistics closely over the next few months, and will base their policy decisions on them.
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