Q&A: How a key Fed interest rate affects the economy
Fed won't 'do anything until it sees the whites of the eyes of a self-sustaining recovery' economist says
WASHINGTON — The recovery from the Great Recession has generated solid stretches of economic growth and job creation, but has failed to impress Federal Reserve policymakers enough to provide a key validation of the economy's strength — an interest rate increase.
That is poised to change as central bank officials signaled that they could raise their benchmark rate as early as this week's policymaking meeting, though analysts don't expect a move until at least September.
The last time the Fed raised the rate was in mid-2006, a year and a half before the start of the worst recession since the Great Depression.
As the economy deteriorated, Fed policymakers ratcheted the rate down from 5.25% to near zero in December 2008 in an attempt to stimulate growth. It has been there ever since.
Despite an uneven recovery, the economy is much stronger today, justifying a rate increase. But the first one would have more of a psychological than practical effect because the Fed probably will increase the rate's target level by only 0.25 percentage point, a small move.
"At the end of the day, it really is more symbolic," said Diane Swonk, chief economist at Mesirow Financial. "It's going to be an acknowledgment of the economy's strength. It's not to combat inflation. It's not to combat an overheating economy."
Fed Chairwoman Janet L. Yellen has said policymakers would decide when to raise the interest
rate based on an assessment of economic data. Even after the initial increase, the rate would probably rise slowly over several years to avoid stalling the economy, she said.
The strategy is known as "lower for longer" and shows how central bank officials are planning to move deliberately to avoid slowing the economy.
"This is a Fed that's not going to do anything until it sees the whites of the eyes of a self-sustaining recovery," Swonk said.
Here are some common questions about interest rates and how the central bank manipulates them to try to help the economy:
Exactly what interest rate is the Fed looking to raise?
When people talk about the Fed raising interest rates, they are referring to the federal funds rate.
Banks are required to hold a set amount of reserves at the Fed. Those reserves are known as federal funds.
The reserves fluctuate daily. So banks that have a surplus can lend the money overnight to banks with less than the required amount of reserves. The rate at which banks make those loans is the federal funds rate.
How does the Fed control the federal funds rate?
As long as the middle class doesn't have really good jobs - like they used to in the 'manufacturing days - the Fed will move this rate slowly. Because they know they will stop the economy dead if they raise it too fast. What I would keep a very strong eye on though is the amount and.Source: www.latimes.com