The Federal Reserve increased interest rates for the first time since the financial crisis. Professor and Chair for the Department of Finance, Insurance and Law Gary Koppenhaver talks about what this means, what happens next, who will win, and who will lose.
What does the Federal Reserve Board’s decision to raise interest rates mean?
Today, the Federal Reserve Board announced a widely-expected increase in the target for short-term U.S. interest rates. The target rate for interbank borrowing was raised by a quarter of 1 percent, to between 0.25 percent and 0.50 percent, effective Thursday, December 17. The rate has remained near zero since December 2008. The effect is to gradually drain funds from the financial system, slow the Fed’s stimulus, and help prevent the U.S. economy from overheating in the future. The interest rate increase could be considered a signal of the current general good health of the U.S. economy after the deep recession of 2007-09.
Where does the Federal Reserve Board go from here?
It depends on the reactions of consumers and businesses. Persistently low U.S. inflation has held down wage increases below Fed targets, which affects consumer spending. A strong U.S. dollar internationally, due to high U.S. interest rates, means foreign imports are cheap and U.S. exports expensive. Because economic growth is slowing abroad, there is uncertainty about how the U.S. economy will fare in the near term. Whether a slow retreat from expansionary monetary policy continues depends on unexpected events in the financial and product markets. Finally, there are time lags between monetary policy changes and full economic effects (approximately nine months) which means the Fed must correctly anticipate future economic conditions.
Who wins and who loses from an interest rate increase?
Winners include investors in money market mutual funds, which should be able to offer higher dividends after the rate increase. Banks and insurance companies are also likely to benefit because these financial institutions have assets that have interest rate-sensitive loan and investment income. Consumers that prefer foreign goods or travel overseas are also winners. The U.S. housing market is not sensitive to short-term rates, and fixed-rate mortgages may react little to the Fed policy change. Losers include businesses with floating-rate debt, unhealthy balance sheets, and multinational markets. Emerging and developing economies could also be pinched by the US rate increase if they experience capital flight and their debt is denominated in U.S. dollars.