Seven years to the day after lowering interest rates to zero, the Federal Reserve on Wednesday took the first step away from the unprecedented emergency monetary measures it began during the recession.
The U.S. central bank announced it would raise its target for short-term interest rates a quarter-point from zero. Now, it will aim to keep rates between 0.25 percent and 0.50 percent.
The Fed said in a statement that it would base further increases on the strength of the economy and that it expected “only gradual increases” in its target rate. Projections released alongside the statement indicated that officials see it rising to 1.4 percent by the end of next year.
That small adjustment “marks the end of an extraordinary seven-year period during which the [target rate] was held near zero to support the recovery of the economy from the worst financial crisis and recession since the Great Depression,” Fed chairwoman Janet Yellen said at a press conference following the announcement. “It also recognizes the considerable progress that has been made toward restoring jobs, raising incomes, and easing the economic hardship of millions of Americans. And it reflects the committee’s confidence that the economy will continue to strengthen.”
Monetary policy still remains stimulative, the Fed claimed. That is, the central bank’s balance sheet remains at an inflated $4.5 trillion, and the Fed’s statement said that it would keep it at that size “until normalization of the level of the federal funds rate is well under way.”
Furthermore, with a promise to raise rates in the future only if the economy improves, a one quarter-percent rate hike won’t prevent businesses borrowing to invest in their companies or stop individuals from taking out mortgages to buy new homes or loans to buy new cars. Yellen and company are betting that growth will be strong enough to push inflation up from near zero now toward the Fed’s 2 percent target next year.
Nevertheless, the rate increase, the first since summer 2006, means that the Fed is planning on tightening money over the months and years ahead, if commerce improves as they expect.
Wednesday’s decision after a two-day meeting of its officials in Washington was long-anticipated. The overwhelming majority of private-sector economists polled before the meeting expected an increase, and futures prices before the meeting indicated that investors had priced it into markets.
The Fed had declined to raise rates in September because of fears that weakness in China and elsewhere overseas could rattle financial markets.
No members of the Fed dissented from the vote.
In a note separate from the monetary policy announcement, the Fed announced the details of how it would implement raising its interest rate target. Those details were kept separate from the announcement because they are technical and the implementation could change depending on how markets react.
Because of the challenge of raising interest rates with $2.5 trillion in excess reserves parked at the Fed, the central bank is using new tools to accomplish its goal. In addition to raising the target for the overnight rate banks charge each other for reserves used to meet regulatory requirements, the Fed will raise two other rates: The rate paid to banks for excess reserves held at the Fed will rise from 0.25 percent to 0.50 percent, setting a ceiling for rates, and the Federal Reserve Bank of New York will borrow through its overnight reverse repurchase facility at 0.25 percent, setting a floor on rates.
Separately, the Fed raised the rate charged on borrowing at its discount window, open to banks facing brief liquidity problems, from 0.75 percent to 1 percent.
