WASHINGTON – Growing concerns about a potential upswing in the inflation rate has led the Federal Reserve to hike the benchmark short-term interest rate by a quarter of a percent – the first such increase in a year.
Janet Yellen, who chairs the Reserve Board, further indicated that future interest rate increases are at the nation’s doorstep, citing a desire to avoid inflation in a strengthening economy.
By taking the action, Yellen said, the board recognizes “the considerable progress the economy has made toward our dual objectives of maximum employment and price stability.”
“Over the past year, 2 ¼ million net new jobs have been created, unemployment has fallen further, and inflation has moved closer to our longer-run goal of 2 percent,” Yellen said. “We expect the economy will continue to perform well, with the job market strengthening further and inflation rising to 2 percent over the next couple of years.”
Yellen said the hike should have only a modest impact on American households, boosting “very slightly” some short-term interest rates, which could have an effect on borrowing costs.
“It’s important for households and businesses to understand that my colleagues and I have judged the course of the U.S. economy to be strong so that we’re making progress toward our inflation and unemployment goals,” she said.
Markets reacted positively to the news the day after the announcement. The Dow Jones industrial average rose 59.59 points, or 0.3 percent, to 19,852.12. The S&P 500 gained 8.74 points, or 0.39 percent, to 2,262.02 and the Nasdaq Composite added 20.18 points, or 0.37 percent, to 5,456.86.
Furthermore, the dollar rose sharply in wake of the hike, pushing it to its highest levels in more than 13 years.
The quarter percent hike – taking the Fed’s key interest rate from 0.5 percent to 0.75 percent – was approved unanimously even though the inflation rate remains at about 1.7 percent, short of the targeted 2 percent mark, reflecting the Reserve’s concern that inflation is becoming a bigger danger than a sluggish economy or even a potential recession.
Interest rates have remained low to stimulate an economy emerging from the horrendous 2008 recession that sent markets in a downward spiral. The low interest rates were aimed at pushing more money into the economy to the benefit of business.
But there exists a drawback to low interest rates – too great a fiscal stimulus leads to inflation, which plagued the administration of former President Jimmy Carter in the late 1970s. The rate hike will dispatch less cash into the economy and could lead to slower growth and higher unemployment. But Yellen and the other governors don’t currently view that as a danger.
“I would say at this point that fiscal policy is not obviously needed to provide stimulus to help us get back to full employment,” Yellen said.
Yellen noted that inflation has increased over the past year. Core inflation, which excludes energy and food prices that tend to be more volatile than other prices, has risen to 1 3/4 percent. As energy prices and prices of imports creep up from their current low levels and the job market strengthens further, the inflation rate will likely rise to 2 percent over the next couple of years.
The Fed decided to act on interest rates now rather than when inflation grows closer to 2 percent to avoid a possible surge in 2018 that could suddenly throw it over the mark and require more drastic rate hikes to corral it, possibly lighting the fuse on another recession.
Regardless, Yellen and the other Reserve Board members don’t think the new hike will adversely affect the economy’s current modest growth.
“The committee judged that a modest increase in the federal funds rate is appropriate in light of the solid progress we have seen toward our goals of maximum employment and 2 percent inflation,” Yellen said. “We continue to expect that the evolution of the economy will warrant only gradual increases in the federal funds rate over time to achieve and maintain our objectives.”
Yellen said gradual increases in the federal funds rate will likely be sufficient to get to a neutral policy stance over the next few years.
Perhaps of greater significance than the current hike – which was expected – were indications from the Fed that it may raise interest rates three instead of the expected two times next year.
Yellen called the revised expectation “a modest adjustment” and said that a number of factors were taken into account – including, in some instances, the anticipated economic policies of President-elect Donald J. Trump.
“The unemployment rate is perhaps a touch, as I said, a touch lower than previously; you’ve seen some modest downward revisions in that projection,” Yellen said. “For this year, there was a slight upward revision to inflation and some of the participants but not all of the participants did incorporate some assumption of a change in fiscal policy into their projections. And that may have been a factor that was one of several that occasioned to these shifts, but I want to emphasize that these, the shifts that you see here, are really very tiny.”
Trump has vowed to increase production capacity through individual and business tax cuts. Yellen acknowledged that tax policy can have an impact on productivity but she passed on assessing the effects of any tax cuts.
“I don’t think there’s anything that I could say in general about what tax policy would do,” she said. “And I really can’t tell you what the Fed’s response would be to any policy changes that are put into effect. I wouldn’t want to speculate until I, we’re more certain of the details and how they would affect the likely course of the economy.”
“I am not going to offer the incoming president advice about how to conduct himself,” added Yellen, whose term lasts until the beginning of 2018.