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There's been a lot of talk about interest rates rising this week with the most recent Fed meeting. Why should you care? Because a spike in interest rates would also affect all consumers who carry a balance on their credit cards.
The Federal Reserve was established in 1913 by U. S. Congress for three key objectives following the Federal Reserve Act: to maximize employment, stabilize prices, and moderate long-term interest rates. The system is unique because it is a private entity outside governmental control that can make monetary policy terms that do not have to be approved by the President or Congress; however, the system does have some public and private sectors. Find out more about how the FED works.
Raising Interest Rates
The Federal Reserve Bank had been meeting this week to vote whether or not they will increase interest rates across the U.S. due to the improvement of the economy following the recession that began in 2008. Once a recession ends, unemployment rates stabilize, consumer spending increases, and inflation becomes a potential threat to wreak havoc to the economy once again. Interest rates rise to calm the economy, and to avoid the threat of another perilous economic recession.
The problem is that although the U.S. economy has improved substantially since 2008, the full recovery to being at the same place we were prior to the recession has not happened yet. Changes to monetary policy take 18 months to incorporate entirely into the system, and the Fed fears that if too much time passes, they will miss their window of opportunity to control the situation before the threat of inflation becomes imminent.
The Fed has a target of 2% inflation for 2015; an increase from their current 1% annual increase. A slight increase in inflation rates are encouraged, since these rates keep wages from going stagnant -or worse- decline. If inflation rates are not increasing slightly, the threat of deflation becomes rather prominent. So it’s true, rising interest rates are inevitable, the question is to how much longer will the Fed be convinced to hold off until the economy has been fully restored.
Other Factors to Consider
Quantitative Easing (QE) is the policy that allowed the Fed to purchase bonds from commercial banks, as well as private and governmental institutions. The Fed currently has close to $4 trillion worth of bonds in their possession. In return, they earn interest off these bonds which increases their annual net income which increases the amount of money that is given to the U.S. Treasury. QE is a policy that only functions properly with interest rates above zero. The policy ended this past October as interest rates have maintained a record low of just over zero for the past six years.
The European Central Bank has announced their implementation of the QE policy, and will be purchasing $1.3 trillion in bonds by fall of 2016, in hopes to remedy their ailing economy. The Fed is concerned that the selling of these bonds will result in a rise of interest rates, and that the impact will happen too quickly if prior action is not taken to avoid such an economic devastation. The goal of the Fed is to ensure that the process is gradual, and to minimalize the risk of any damage to the American economy.
The Federal Reserve made a statement at the conclusion of their meeting Wednesday afternoon saying that they are willing to remain “patient in normalizing the monetary policy.” This statement mirrors one made after the December 2014 meeting, and it appears that regardless of the recent economic events, the Fed committee voted unanimously to postpone any adjustments to current rates. So for now, interest rates will remain unaffected; however, the statement released did hint to the fact that they will not stay this way for much longer.
Some economists and market analyzers were hoping that the increase would be put off until the end of the year, or even next year. Unfortunately, we can likely expect to see a climb in interest rates by early summer 2015 at the latest. Some estimate a quarter point rate increase this year.