Steady and sustained economic growth near the Federal Reserve’s annual target of 2% has indicated to the FED’s officials that after years of zero interest rates on FED funds to banks that it is time to raise the rates.
In addition, as inflation rates increased, hiring increased and unemployment decreased. It has been estimated that 210,000 jobs have been added each month in 2015. Unemployment has fallen below 5% from 10% in 2009 (NY Times).
Since 2007, no other country has been able to maintain above zero interest rates and many countries in Europe are providing government money to banks at negative interest rates.
The much anticipated December 15th and 16th meetings on raising FED funds rates resulted in a unanimous agreement that the Federal Reserve will increase interest rates. The agreement raises rates on FED funds to a range of 0.25% to 0.50%. This is from the low that has remained at 0.00% to 0.25% for nearly a decade. Fed funds determine the rate that banks loan money for car loans, home loans, and credit. There are plans to increase the FED funds rate over the next 3 years. The goal is to increase the target interest rate. Interest is projected to be 1.375% in 2016, 2.375% in 2017, and 3.25% after 3 years (NY Times)
Expectations of the rate increase caused stocks to rise; the Dow increased 1.28% by 224.18 points with a slight initial drop after the official announcement of the raise increase on the 16th (NY Times).
The goal is that the Federal Reserve can implement a sufficient interest rate and maintain economic growth of 2%. The economy is not strong if it relies on expansionary policy; zero interest rates and bond buying to support and stimulate the economy.
Expansionary policy is an expense to the government for loaning money at no interest and buying billions of dollars of private bonds to stimulate the economy but in times of recession it is an insurance to investors that there is some regulating force in the markets and can keep the markets from dropping further.
The effects of the interest rate increase reach markets around the world. Foreign banks control about 15% of U.S. assets, in addition, many overseas banks have U.S. charters, or receive significant U.S. funds.
Many foreign and domestic banks use reserve rate funds and some say they will benefit the most from the increases initially. Foreign banks received about half of the $6.25 of reserve funds this year and the rate doubled from 0.25% to 0.50% with the FED’s mid-December decision. This large portion of interest is paid to foreign banks because they maintain a large segment of the reserve funds market. “For the week ended Dec. 2, foreign firms had parked closer to $1.2 trillion at the Fed, or 47% of total reserves. Both foreign and domestic banks can borrow money overnight at low short-term rates and park them at the Fed at a higher rate, earning a profit or “spread (WSJ, 2015).”
Impact in Eastern Europe, Western Asia, North Africa, and Turkey is expected to be minimal but the amount of money they can barrow, inflows, will decrease as the cost, interest rates increases. The rise in interest rates also has a macroeconomic impact through the micro economic impact. Households barrow less or spend less as interest rates increase; car loans, homes, credit cards (WSJ, EBRD).
The most important point is that this rate increase and the associated indicators are signs of economic recovery. Once again the economy is reaching the goals for optimum and sustainable growth. Domestically, slight increases are expected to balance growth, inflation, and the current drop in crude oil prices. This pushed the economy to grow on investment and development rather than inflation.