The Fed's Rate Hike:What Was Behind It and What It Means

The Federal Reserve announced today that it is hiking the Fed Funds Rate,its iconic interest rate,by 0.25%.*
This action marks the end of an extraordinary seven-year period during which the Fed Funds Rate was held near zero,said Federal Reserve chair Janet Yellen at a post-announcement press conference.It reflects the Open Market Committee's confidence that the economy will continue to strengthen.The Committee judged that a modest increase in the FFR target is now appropriate.The labour market has clearly shown continued improvement.Overall,the Committee sees the risk to both the labour market and economic growth as being balanced.
Low energy prices and the appreciation of the dollar have weighed on inflation.Long-term inflation expectations remain anchored.In considering future policy decisions,we will carefully monitor progress towards our 2% inflation goal.The limit on inflation is due to transitory factors which we expect to slacken over time.An abrupt tightening could increase the risk of pushing the overheated economy into recession.*
It's important not to overblow the significance of this first move-it's only a quarter of a percent.The policy we judge to be accommodative.I continue to judge there is slack in the economy:the depressed level of labour participation and the high level of part-time employment.With rates close to zero,we have less room to respond to negative shocks.If we do not begin to slightly reduce the amount of accommodation,the odds are good the economy would overshoot our goals.
It doesn't mean we need to see inflation reach 2% before we move again.I'm not going to give you a simple formula for when we would move again.It could be on a variety of different forms of evidence,but I don't want to give a simple benchmark.We do expect inflation to be moving up,but we don't expect it to reach 2%.
All oil prices need to do for us to reach our inflation goal is stabilise.I certainly grant that we've seen a number of shocks,but we don't expect them to drop much lower;but to stabilise.Market expectations are for oil to stabilise for awhile and then move up.*
Were there an unexpected,persistent change in financial market conditions,we would need to take them into account.I do not think that expansions die of old age,but the economy does get hit by shocks,and there are significant odds that the economy hits some unforeseen shock that sends it into recession,and of course we would respond.Some European central banks have cut their overnight lending rates;we could study taking the overnight rates into negative territory.This is something we have contemplated-our options.It would be nice to have a buffer in the FFR,to have some ability to respond.We have a far more resilient financial system now than we had before the financial crisis,but we will be evaluating this carefully.*
For average Americans,the Fed's decision reflects our confidence in the US economy.We see an economy that is on the path of sustainable improvement.I hope they will take this to mean that conditions will continue to strengthen and job prospects will be good.Some consumer borrowing rates,some credit card rates (and adjustable rate mortgage and small business loan rates) may move up slightly.
Gradual rate hikes does not mean mechanical,evenly spaced hikes.We will be data-dependent,and as the conditions evolve,we will take them into account.*
We are constantly monitoring foreign economic developments;we understand that our fates are linked.We've made a commitment to the emerging market policy makers that we will communicate as clearly as we can to avoid spillover to the emerging markets.Our economy doing well is encouraging to other economies around the globe.We have taken care to avoid unnecessary negative spillover to the emerging markets,Fed chair Janet Yellen told the reporters.*
In sum,the Fed judges that the US economy is doing so well,they need to slow it down it a bit,so it doesn't overheat into high inflation and another recession.The way they do that is by raising the Fed Funds Rate,which raises the rates on certain consumer loans such as credit card balances and adjustable rate mortgages.