In a widely expected move, the U.S. Federal Reserve decided to raise interest rates for the first time in 2016 and the second time in a decade. At the conclusion of its two-day Federal Open Market Committee (FOMC) December meeting, committee members voted unanimously to raise the U.S. central bank’s target range for the federal funds rate to 0.50 to 0.75 percent. The FOMC raised interest rates for the first time in nearly a decade last December.
In a press conference following the decision, Federal Reserve Chairwoman Janet Yellen said: “My colleagues and I are recognizing the considerable progress the economy has made toward our dual objectives of maximum employment and price stability … We expect the economy will continue to perform well, with the job market strengthening further and inflation rising to 2 percent over the next couple of years.”
This past year has been one of changing, and at times divergent, Fed expectations: At the beginning of the year, FOMC members projected four rate hikes for 2016. The Fed also struggled with aligning market expectations for rate hikes with its own. Additionally, solid jobs numbers paired with weak inflation data made a case for waiting.
“The Fed has not seen significant inflation pressure or wage pressure, and was concerned about the pace of economic growth. So they waited until the end of the year,” said Randall Kroszner, an economics professor at the University of Chicago Booth School of Business and a former Governor of the Federal Reserve System. “I think it would have probably been wiser to move a little bit earlier, but one quarter of a percentage point September vs December is not going to make or break the U.S. or the world economy.”
Interest rates are still at historic lows, with some asking throughout the year whether low interest rates have become the new normal. Monetary policy makers, on the other hand, expressed that they have been waiting for the right conditions to gradually move interest rates toward more normal levels. At the Fed’s November meeting, only two members felt it was time to raise rates. This month’s meeting yielded a unanimous decision to raise the federal funds target rate.
As for next year, currently the Fed’s updated projections now signal three quarter-point rate increase; the median of committee members’ predictions is that the federal funds rate will be 1.4 by the end of 2017.
“Given the dot plot forecast for roughly four rate hikes last year, which ended up being just one hike at the end of the year, [it] raises questions about how much weight you want to put on those dot plots,” said Kroszner.
Fed watchers and economists are expecting that Yellen and the Fed will soon start taking into account the economic policies of President-elect Trump and their consequences. To that end, one prediction is that expected economic stimulus would be followed by inflation, and then subsequent tightening of monetary policy to prevent the economy from overheating.
“My hunch is that the dot plot forecast is going to be closer to reality next year than it was this year,” said Kroszner. “I think it's more likely that they'll move more than once next year, given the likely change in policy. But there's still a lot of uncertainty about that, and that's going to drive how quickly they will raise rates: Changes in expected inflation and policy are the key things that will be driving [the Fed’s] changes.”