The FOMC (Finally) Raises Rates

Economic Pulse
December 16, 2015
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The Federal Open Market Committee voted unanimously to raise its Federal Funds rate target today as expected, bringing the benchmark rate higher by 25 bps to a range of 25 bps - 50 bps. The move marks the first time that the Fed has increased rates since 2006. Three other rate changes were announced as well: the discount rate—the interest rate charged to commercial banks and depository institutions on loans received from their regional Federal Reserve Bank's lending facility—was raised from 75 bps to 1%, while a new floor and ceiling were set to manage the Fed Funds target: the overnight repurchase rate was set at 25 bps, while the interest rate paid on excess reserves was raised from 25 bps to 50 bps.

In addition to today’s policy announcement, the Committee also released its quarterly economic projections. Once again, growth and unemployment rate forecasts were trimmed slightly for both 2016 and 2017. What is notable is that despite the reduction in the growth outlook, the Committee still sees a median Fed Funds rate target of 1.375% by year-end 2016—which implies four additional rate hikes in 2016, despite the fact that today’s communique references both “gradual adjustments” and gradual increases” in the target rate.

In a speech following the policy announcement, Chair Yellen addressed the question as to why the committee chose to raise its target rate “in light of the current shortfall of inflation from 2 percent.” She noted that “factors restraining economic growth” (such as low oil prices and a strong dollar) are expected to abate over time, while “diminishing labor market slack should help boost inflation.” She noted that if the Committee delayed the first move for too long, it would need to tighten policy relatively abruptly to prevent the economy from overheating, where “such abrupt tightening [would] risk pushing the economy into recession.” In short: the Committee hopes that a rate hike now, in line with market consensus, will prevent an unnecessary shock to the economic system later.

Table 1. Economic Projections of Federal Reserve Board Members and Presidents, December 2015