The Federal Reserve has raised interest rates by one quarter percentage, the first in seven years when the U.S. tumbled into a deep financial crisis with the collapse of the Wall Street, writes Lalit K. Jha. (@Siliconeer, #Siliconeer, #USFederalReserve, #TiESV, #CARealtors, #Realtors, #RealEstate, #Mortgage, #HomeLoans)
“The Federal Open Market Committee decided to raise the target range for the federal funds rate by one quarter percentage point bringing it to one quarter to one-half per cent,” U.S. Federal Reserve Board Chairwoman Janet Yellen told reporters at a briefing.
This action marks the end of an extraordinary seven-year long period during which the Federal Reserve funds rate was held near zero to support the recovery of the economy from the worst financial crisis and recession since the Great Depression, she said.
It also recognizes the considerable progress that has been made toward restoring jobs, raising incomes and easing the economic hardship of millions of Americans, Yellen said.
The decision reflects the committee’s confidence that the economy will continue to strengthen, she said, adding that the economic recovery has clearly come a long way, although it is not yet complete.
“Room for further improvement in the labor market remains and inflation continues to run below our longer run objective.
But with the economy performing well and expected to continue to do so, the committee judged that a modest increase in the federal funds rate target is now appropriate. Recognizing that even after this increase, monetary policy remains accommodative,” Yellen said.
According to Yellen, the process of normalizing the interest rates is likely to proceed gradually, although future policy actions will obviously depend on how the economy evolves relative to their objectives of maximum employment and two percent inflation.
“Since March, the committee has stated that it would raise the target range for the federal funds rate when it had seen further improvement in the labor market and was reasonably confident that inflation would move back to its 2 percent objective over the medium term,” she noted.
Yellen said the Federal Reserve currently expects that with gradual adjustments in the stance of monetary policy, economic activity will continue to expand at a moderate pace and labor market indicators will continue to strengthen, although developments abroad still pose risks to U.S. economic growth.
These risks appear to have lessened since last summer, she observed.
Following the announcement Rahul Shah, vice president, Equity Advisory Group, Motilal Oswal Securities said the rate hike going forward will be gradual and data driven.
“After seven years of the most accommodative monetary policy in U.S. history, the Fed, as widely expected, approved a quarter-point increase in its target funds rate. Rate hike as expected, in line with street estimate, and in short comment of Yellen, that Rate hike going forward will be gradual and data driven,” Shah said.
Yellen told reporters that the median projection for real GDP growth is 2.1 percent for this year and rises to 2.4 percent in 2016.
“Thereafter, the median growth projection declines toward its longer run rate. The median projection for the unemployment rate in the fourth quarter of this year stands at 5 percent, close to the median estimate of the longer run normal unemployment rate,” she said.
Fed also approved a 0.25 percentage point increase in the discount rate for primary credit, to one percent.
“Based on the extensive testing of our policy tools in recent years, the committee is confident that the normalization process will proceed smoothly,” she said.
Responding to questions, Yellen cautioned against overblowing the significance of this first move.
“It’s only 25 basis points. If monetary policy remains accommodative, we’ve indicated that we will be watching what happens very carefully in the economy in terms of our actual, and forecast, our projected conditions relative to our employment and inflation goals,” she said.
Acknowledging that the Fed has been concerned about the risks from the global economy, she said the US economy has shown considerable strength.
“Domestic spending that accounts for 85 percent of aggregate spending in the U.S. economy has continued to hold up.
It’s grown at a solid pace,” she said.
“While there is a drag from net exports, from relatively weak growth abroad and the appreciation of the dollar, overall, we decided that the risks to the outlook for the labor market and the economy are balanced,” Yellen said.
“We recognize that monetary policy operates with lags. We would like to be able to move in a prudent and, as we’ve emphasized, gradual manner. It’s been a long time since the Federal Reserve has raised interest rates, and I think it’s prudent to be able to watch what the impact is on financial conditions and spending in the economy,” Yellen added.
Yellen said the historic decisions about increase in interest rate was “well communicated” with the emerging markets as she acknowledged that the performance of the U.S. economy has important spillovers on to emerging markets.
“We’ve made a commitment to emerging market policymakers that we would do our best to communicate as clearly as we could about our policy intentions to avoid spillovers that might result from abrupt or unanticipated policy moves,” Yellen, 69, said.
“I think this move has been expected and well- communicated. At least I hope that it has. So I don’t think it’s a surprise,” Yellen said, responding to a question if she is concerned about the negative impact that the decision could have on the emerging markets.
Yellen did not name any particular country but described them as emerging market, which includes India.
“We are constantly monitoring foreign economic developments, including those in emerging markets. We understand that in the global economy with integrated product and capital markets that our fates are very much linked. And that the performance of the U.S. economy has important spillovers on to emerging markets and vice versa. We have been trying very carefully,” she said.
The decision by the Federal Reserve to increase the interest rates takes place in the context of a U.S. economy that is doing well, she observed.
“It is a source of strength to the emerging markets and other economies around the globe. And so there can be negative spillovers through capital flows, but remember there are also positive spillovers from a strong US economy. My general view is that many emerging markets are in the stronger position than they would have been in the 1990s,” Yellen said.
For example, they have stronger macroeconomic policies.
They have taken steps to strengthen their financial systems and are better positioned to deal with this, she said.
“On the other hand, there are vulnerabilities and there are countries that have been badly affected by declining commodity prices, so we will monitor this very carefully, but we have taken care to avoid unnecessary negative spillovers,” Yellen said.
Responding to another question, Yellen said there are many countries that are undergoing very difficult adjustments or slowing growth, especially with declining commodity prices.
“But even recently, we’ve seen growth in emerging markets strengthen. And so it is not only downside risks, but, you know we do pay attention to downside risks. But the committee said they regard the risks overall as balanced,” Yellen said.