On December 16 2015, the Federal Reserve System announced that it would raise interest rates. This is causing turmoil in US financial markets, since it is the first time since the 2008 Great Recession that interest rates are rising.
Commonly known to financiers as “The Fed”, this is the central bank of the United States, which acts as a public entity and caters to the interests of the United States’ general financial stability, unlike private banks that seek only profit.
The Fed played a major role in the Great Recession of 2008. It purchased large quantities of Mortgage-Backed Securities, which were failing investment products that many major private banks owned but could no longer sell. The Fed also lent enormous amounts of cash to some of the largest banks in America, preventing these banks from failing, and thereby preventing a ‘domino effect’ collapse of other US banks, the financial industry, and subsequently the entire economy.
How does this explain the current calamity over interest rates? When lending to these banks in 2008, The Fed lowered the Federal Funds Rate (the interest rate that banks pay on overnight loans to each other, which keep them in business) to as low as .25%, easing the financial burden on the panicking banks. The Fed maintained rock-bottom interest rates for years following 2008 in order to prop-up the US economy and prevent a full-force depression.
Eight years later, the US is in a state of faux-growth; the economy is growing, but household income has not grown significantly. Additionally, young people of the millennial generation are struggling to gain financial traction, spending much of their incomes on student loan interest payments, or monthly rent. As opposed to a mortgage on a home, which builds ownership value with each monthly payment, paying rent brings no return on investment, and is sucking up much of the savings of young Americans.
Because of these conflicting economic signals, Americans are worried that the US economy escaped the frying pan only to fall into the deep fryer. This makes raising interest rates a challenging task for members of The Fed, who hope that the US economy is finally strong enough to progress without artificially low interest rates. Only one fact is now certain: the quest to return interest rates to pre-recession levels (an action known as Normalization) has begun.
The Fed’s approach to raising interest rates is like that of a nervous child entering a swimming pool; test the waters slowly, with small changes over time. On Wednesday, January 27th, The Fed announced that it would not raise interest rates until at least March, if not later.
A daunting task lies in front of The Fed to remove the floats from the US economy’s arms. US financiers are more worried than ever, wondering whether the economy will sink or swim. At the very least, the recession is behind us, and the economy continues to grow (kind of).