It’s the end of an era. For the last time under chair Janet Yellen’s tenure, the Federal Reserve once again affirmed the economy’s strength by deciding to raise the cost of borrowing: Changing interest rates is the main way that the United States central bank pursues its “dual mandate” to make sure as many people as possible have jobs without prices rising too quickly.
So what’s the change? The Fed announced it would be raising the federal funds rate from the current range between 1% and 1.25% — to a higher range of 1.25% to 1.5% — the third rate hike of the year and the first since June. Then, starting in 2018, the world’s most powerful central bank will be under the stewardship of President Donald Trump-appointed Jerome Powell.
The Fed’s latest statement says: “The Committee continues to expect that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market conditions will remain strong. Inflation on a 12-month basis is expected to remain somewhat below 2% in the near term but to stabilize around the Committee’s 2% objective over the medium term.” In other words, the central bank is still feeling optimistic.
Even for the Fed — which is known for a slow, deliberative approach to decision-making — the choice to raise interest rates has been in the works for awhile: essentially a “foregone conclusion,” Bankrate chief financial analyst Greg McBride said. “The Fed doesn’t not want to surprise markets,” he said. “If they raise rates and everybody shrugs, it’s mission accomplished.”
The reason for all the caution? Stock markets typically get skittish around any uncertainty about how quickly or often the federal funds rate changes — since that rate influences all the other interest rates in the economy, affecting anyone borrowing money, lending money, saving or looking for a job.
Does the Fed interest rate hike affect me?
When the Fed changes interest rates, the cost of borrowing money by using a credit card, taking out a mortgage to buy a home or even taking out student loans can all get incrementally more expensive. That means now is as good a time as any to pay down debt and refinance outstanding variable interest loans. Higher interest rates can also slow the economy and thus reduce hiring — meaning it might be time to hustle to lock down a new job.
On a more positive note, higher interest rates mean you can earn more cash from a high-yield savings or checking account — so it’s additionally a good time to start shopping around for a better account.
Though today’s announcement was not a big surprise, next year’s Fed meetings might ratchet up the drama. Many economists were big fans of Yellen, rating her highly, and had actually wanted to see her remain in the job by wide margins.
Still feeling confused? Here are three more issues to know about on the current rate hike and how actions by the Fed next year could affect you.
1. Last time a non-economist was in charge, life got expensive
If you’ve ever shopped for groceries or applied for a job, the Fed has had a hand in your experience. Not only are its two main responsibilities — making sure everyone has jobs and keeping price inflation at a healthy rate — important, they’re also at odds with one another. Because this is such a delicate balance, there’s been some concern that Powell will be the first Fed chair in decades who is not a professional economist with a PhD in the field.
The last time that happened was the tenure of former Fed chair William Miller, who as Quartz noted was a bit of a “disaster.” Miller’s tenure, between 1979 and 1981, was marked by high inflation mixed with unemployment. This is a deadly combination known as “stagflation,” which is when goods and services get more expensive, but wages don’t rise enough to allow people to afford them.
To be fair, there was plenty going on in the mid-to-late 1970s that didn’t help — including an energy crisis — but 2018 will likely have its own headwinds and complications, too. The Fed has to undertake a new challenge, in fact: Reducing the balance sheet, aka trillions of dollars in assets the bank acquired in the wake of the financial crisis to help support the economic recovery.
“There’s legitimate concern about a non-economist heading the central bank of the world’s largest economy, particularly at such a critical juncture,” McBride said. “We’re changing pilots as we’re landing, because we’re both changing interest rates and unwinding the balance sheets. Never before have we been in the position to do both, so the potential for a misstep is heightened.”
Translation? For the next several months, the Fed will be in a period of transition, and even if the Fed succeeds in making its change of the guard as boring as humanly possible, it’s still an unfortunate time for its governors to be trying to find their sea legs.
2. People are still not getting the raises they deserve
If you’ve been feeling left out of this economic recovery, you’re hardly alone: One of the reasons why observers are concerned about a leadership change at the Fed has to do with the labor market. Unemployment has been steadily falling for years, but the economic recovery has also been incredibly uneven. Back in the fall, the economists at Goldman Sachs wrote a letter to clients where they called the labor market “divided.”
In one labor market, you have people with college degrees clustered in booming cities, hopping quickly from job to job and gaining raises in the process. In the other labor market, you have people who are isolated from these good jobs, whether because of education, geography or having been formerly incarcerated. As a recent Bloomberg story noted, people who thus far have been isolated from the recovery are only just now beginning to start finding jobs.
That would suggest that the labor market still has room to grow, and that increasing interest rates runs the risk of further alienating vulnerable groups from the economy, Shawn Sebastian, co-director of the Fed Up campaign at the Center for Popular Democracy, said.
“When there is so much demand for labor that workers are able to bargain for better wages, when a woman who is sexually harassed by her boss can quit and go across the street and get another job, then we’re at full employment,” Sebastian said. “We’re very far from that.”
Indeed, people at the bottom of the employment ladder did start getting raises in the last year, but these have not been enough to make up for lost ground. Wage growth for temporary workers was about 5% in September, their biggest raise in almost a decade — but still markedly less than the nearly 7% raise they got in September 2007, before the recession hit.
“If you’re a software coder in Silicon Valley working for a tech company, or a biotech researcher in Boston ... your recovery is doing really well,” investor Barry Ritholz said. “But if you’re in the part of a country where the economy is still lagging, if you’re working in the lower end of healthcare or retail or food services and you have a high school or an associate degree, your personal recovery is terrible.”
Finally, despite a series of recent strong recent jobs reports — including the latest one on Friday — some experts point out that jobs estimates often turn out to be much lower than originally reported, after revisions are made the following month (when people aren’t paying as much attention).
3. There’s strength in numbers — but the Fed will enter 2018 with a small bench
A final reason this particular Fed meeting was so important? Next year is expected to be tumultuous: Yellen’s departure left four vacancies on the Fed’s Board of Governors, the most in its history, as the New York Times’ Binyamin Applebaum recently noted. Bankrate’s McBride agreed that this could make for a particularly unpredictable year at the world’s most powerful central bank.
“The makeup of the entire Fed that could change notably over the next 12 months,” McBride said. “And that’s what will prove to be the deciding factor” in how much the direction at the Fed will really change.
Keep in mind: The Fed’s economic projections are not terribly reliable, Ritholtz said, and tend to be numbers that “rationalize” decisions the Fed has already made. That suggests decision-making at the bank could change substantially next year — regardless of the how the economy is doing.
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