Why is the Fed Still Raising Interest Rates?
Despite several years of economic growth, the Federal Reserve has continued to steadily raise the federal funds rate, confounding economists and investors alike. In December 2018, for instance, the Fed raised the rate for the fourth time in the year. So why is the Fed still adjusting interest rates? This article will explain the rationale behind the Fed’s decisions and offer some perspective on what the trajectory of interest rates could look like in 2019 and beyond.
Understanding the Federal Funds Rate
Before we can discuss why the Federal Reserve is raising interest rates, it’s important to understand what the federal funds rate is. Put simply, this rate is the interest rate banks charge each other for overnight loans. More specifically, it is the rate at which banks lend the Federal Reserve’s balance sheet reserves to other banks.
The Federal Reserve sets this rate to influence the economy. For instance, when the Federal Reserve lowers the federal funds rate, lending among banks becomes cheaper, which allows banks to more easily lend money to consumers. This makes it easier for people to buy things like cars and homes, stimulating economic activity. Conversely, when the Fed raises the rate, it becomes more expensive for banks to borrow money, so they must charge more to borrowers. This, in turn, reduces consumer spending, as it is more difficult to afford large purchases like cars.
Why the Federal Reserve is Raising Interest Rates
The obvious question is why this rate is being raised – the answer is that the Federal Reserve is attempting to prevent the economy from growing too fast. It is a classic case of better to be safe than sorry.
In the last few years, the U.S. economy has grown steadily, with unemployment at an all-time low and consumer spending on the rise. While this is certainly positive news for the country, it can also be a sign of economic overheating. When too much money is circulating in an economy, prices can spike and monetary inflation can occur. This inflation can lead to complications, particularly when it comes to international trade and competitiveness.
By raising interest rates, the Federal Reserve is attempting to slow down the rate of growth in the economy. In other words, they are attempting to avoid an unhealthy economy by preventing over-stimulation and excess spending.
What Could the Future Hold?
At this point, it is hard to predict exactly when the Federal Reserve will stop raising interest rates. However, we can make some educated guesses.
The Fed is currently predicting two more rate hikes in 2019, but this is far from a sure thing. The latest economic data has been mixed and it is not clear how future policy could be impacted. The decision will likely come down to whether or not the Fed feels confident the economy can handle higher interest rates without slowing down too much.
In addition, it is worth noting that the Fed has been historically cautious and often err on the side of caution. This means that, while they could potentially stop raising rates at some point in the coming year, it is more likely that the trend of steady rate hikes will continue.
The Federal Reserve is continuing to raise interest rates in order to ward off the risks of economic overheating and inflation. While it is difficult to predict when this trend will end, it is safe to say that the Fed will likely err on the side of caution, meaning that rate hikes are likely to continue for the foreseeable future.
