This isn’t the time to raise short-term interest rates, the Federal Reserve said today. With turmoil in the European financial system and high unemployment in the United States, the central bank took a cautious course.
The Fed’s rate-setting committee kept its target for a key short-term interest rate near zero percent, as expected, and pledged to maintain this ultralow rate policy for a good while longer. The central bank has held the federal funds rate near zero percent since December 2008.
“With what’s going on in Europe and elsewhere, they’re hard-pressed to make any significant changes,” says Kenneth Thomas, a finance lecturer at the Wharton School of Business at the University of Pennsylvania and a scholar of the Fed.
A financial and fiscal crisis in Greece has been rocking the European Union since December, and four other countries — Ireland, Italy, Portugal and Spain — are shaky, too. And in the United States, unemployment remains high and new home sales fell to a record low in May.
In this environment, the last thing the Fed wanted to do was surprise anyone.
“Overall, this is a classic case of expecting nothing, expecting no change, because it’s pretty clear-cut,” Thomas says.
Less than zero
Narayana Kocherlakota, president of the Federal Reserve Bank of Minneapolis, put it this way in a speech last month: “We can’t set interest rates to be negative. This means that the question, ‘What’s going to happen to interest rates?’ is an even less interesting one to use at cocktail parties than usual.”
Ben Bernanke, chairman of the Fed, told a House committee this month that he expects the economy to grow at about a 3.5 percent clip for the rest of the year and for inflation to remain low. With most measures of inflation running well below 2 percent, the Fed continues to keep the money spigot open by holding short-term rates low in an effort to buoy the economy.
To that end, the Federal Open Market Committee kept its target for the federal funds rate in a range between zero percent and 0.25 percent. Banks make overnight loans to one another at the federal funds rate, which influences the prime rate and other short-term rates.
The prime rate will stay at 3.25 percent. Rates on home equity lines of credit and variable-rate credit cards will remain unchanged. Rates on short-term certificates of deposit will linger in the cellar.
Short-term interest rates are heavily influenced by the Fed. On long-term rates, the Fed’s authority is indirect. Longer-term interest rates are set by market forces, and not by the Fed.
So, while it’s easy to predict that short-term rates won’t move much over the next few months, the prospect is less certain for longer-term interest rates on mortgages and lengthy certificates of deposit. Rates on those instruments are very low right now. It’s anyone’s guess how long they’ll remain that way.