Who’s on the Federal Open Market Committee? What’s the federal funds rate? And how do they affect the U.S. economy and the American people?
PNC’s Chief Economist Stuart Hoffman explains the Federal Reserve and potential impact for consumers of a rising Fed funds rate.
POV: Why all this talk about the Federal Reserve and raising interest rates?
HOFFMAN: It’s no secret that the U.S. economy was on life support following the financial crisis. The Federal Reserve – or Fed – has played a significant role since then in restoring the economy to better health. The Fed is the central bank of the United States – most nations have one – and is charged with maintaining the stability of our financial system, fostering full employment and keeping inflation low.
The Federal Open Market Committee (FOMC), which was formed by the Federal Reserve Act of 1913, makes decisions for the Fed. The 19 committee members (seven Board of Governors and the 12 Reserve Bank presidents) meet eight times a year.
This committee used every available option to save the economy from total collapse during the Great Recession of 2008-09. This very slow recovery included reducing the federal funds rate to near zero in late 2008 and keeping it there until December 2015 when it was increased, but only by 0.25 percent. The Fed didn’t raise rates again until December 2016 with a similar 0.25 percent increase.
POV: How does the federal funds rate work?
HOFFMAN: In short, it’s the interest rate at which banks and other financial institutions borrow from one another. More importantly, this rate cascades, influencing interest rates for just about everything, including mortgages, car loans, student loans, credit cards and more.
You may have bought a house in the last couple of years because mortgage rates were historically low. You can thank the Fed. The Fed intended to stimulate economic growth by getting consumers and businesses to start spending and investing again.
The Fed looks at the vital signs of economic health, including job growth, wage growth, consumer spending and housing activity. When these vital signs are strong, the FOMC starts to notch up interest rates. After the 0.25 percent rate increase in December of last year, the Fed held rates steady throughout this year due to fluctuations in economic growth (GDP) and low inflation.
POV: How would a rate increase affect the average American?
HOFFMAN: Most likely it would impact every one of us in some way. For one thing, people with adjustable rate mortgages will notice their interest rates go up. Individuals on the verge of buying a house may find mortgage rates notching up as well. It may cause temporary volatility for stock investors, but should feel good for those who have been earning zero interest on bonds and CDs, as those rates finally start to come alive.
POV: How quickly? Will a car buyer see a loan immediately cost more?
HOFFMAN: Rates won’t go up on a car loan that same day. The markets have been anticipating a rate increase for some time and already have factored in some upward rate adjustments. If you are thinking about buying a home in the next six months or a year, for example, you could see a couple of quarter percentage point rate increases over that time.
Remember, you may see higher interest rates as a borrower, but the interest you are paid on deposits will begin to increase as well.
POV: When do you expect further rate increases?
HOFFMAN: We think the Fed is going to move slowly, not a series of rapid-fire rate increases at every FOMC meeting. That is exactly what happened in 2004-06 when the FOMC raised rates at 19 meetings in a row. We don’t think that is the right prescription for FOMC action this time.
After the seven year, near-zero rate following the Financial Crisis and Great Recession, it was a year between the first FOMC rate increase in December 2015 and the next one in December 2016. Both were small increases of 0.25 percent each.
We are forecasting two additional 0.25 percent hikes in 2017. This approach would result in a much slower, more deliberate pace of ascent over the next 2-3 years, bringing that rate near 2.0 percent in 2019.
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