The Fed Successfully Raises Short-Term Interest Rates

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According to Stanley Fischer, the Vice Chairman of the Federal Reserve, the organization’s newly developed toolkit has successfully raised the federal funds rate after the decision was made in December to finally increase interest rates from their near zero state.

Surprising Success

The Federal Reserve held a vote mid last month, finally approving the increase of the Fed funds rate from near zero to between 0.25 and 0.50 percent. The rates have been near zero for the past seven years, since the financial crisis in 2008.

Concerns were raised about the ability of the Fed to increase the rates due to the current overflow of cash in the money market which would normally offset any increase in rates. However, those concerns proved unfounded as the rates moved up into the higher range just a day after the decision was made.

Gradual Rate Increases

For months prior to the interest rate raise, the Federal Reserve had been focused on discussing the equilibrium real interest rate concept, an issue that was highlighted in comments after the successful increase in the rates. As the rate is considered to be near zero it will most likely only increase gradually, leaving the possibility for a return to interest rates that are near zero sometime in the future.

An additional issue that was highlighted after the decision to raise rates, was the role financial stability played in the process of decision making. What had to be taken into account was the fact that while the country itself does have various macro-prudential tools it can use, the Fed itself has fewer of the same when compared to other central banks, most notably concerning real estate.

It was also pointed out that asset prices may have to be used to decide if the economy is developing new bubbles and if tighter financial policies are required, reflecting a potential future shift in policy.

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