The Fed to increase short-term ratesThe Federal Reserve (the Fed) has made clear its intention to start raising interest rates by the end of 2015. The short-term interest rate (called the Federal Funds rate) has hovered in the 0%-0.25% range since 2009. By keeping the short-term rate near zero, the Fed indirectly keeps mortgage rates low, encouraging homeownership and borrowing by households and businesses.
The Fed’s consideration for increasing the short-term rate is based on targets for:
- a “maximum” nationwide employment rate; and
- inflation expectations of 2%.
How does this work? At a basic level, when the short-term interest rate is lowered, borrowing, spending and inflation tend to rise. When the Fed raises the short-term rate, borrowing, spending and inflation cools down. However, today’s inflation rate remains below the target 2% inflation objective for a normally functioning economy.
Thus, the Fed has kept the short-term rate as low as it dare go – zero – to encourage a higher rate of inflation, which it has not yet achieved in seven years.
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