Due to the vast weakening of the domestic and global economic environment by the aftermath of the financial crisis, that lead to the great recession. The Fed kept interest rates at 0% for nearly a decade to cushion the hit, and increase liquidity, to ease credit markets (FRED, 2015). But low-interest rates for too long presented a dilemma for the Fed, it has not generated any upward pressure on inflation, and previous efforts from the QE bond buying program did not stimulate inflation (WSJ, 2015). The Federal Open Market Committee (FOMC) met on September 16 & 17 of 2015, and decided not to increase the interest rates, maintaining a [0,0.25] percent target range for the federal funds rate (FRB1, 2015). There are many interconnected factors that contributed to their decision. Among them was the current weakening of global demand, especially in China. The current and potential appreciation as a result of an interest rate hike would increase the demand for the US dollar, would negatively affect net exports even more and slow the growth of the economy. Another key factor is the low inflation rate, that has been below its 2% preferred measure for several years (The Economist, 2015). However, the committee claims that the recent drop in energy prices has put downward pressure on inflation, and are thus waiting for the prices to rise, and stabilize (FRB, 2015). During the press conference held by Chairwoman Janet Yellen, the lag of the labor market’s adjustments relative to wage growth and actual unemployment rate was addressed and it was concluded that she would like see further improvements in the labor market that should generate some inflation, before raising interest rates (C-SPAN, 2015). Since wage growth has been shy of expectations in comparison to previous post recovery periods (The Economist, 2015). The current low rates have fueled auto sales and the commercial real estate while also contributing to the steady decline in the unemployment rate peaked 10% in 2009 to 5.1% in August 2015 (Hilsenrath, J, 2015). From a political stance, the U.S government depends on deficit spending, once interest rates increase, interest payments are going to be larger, and harder for the government to maintain a balanced budget. Hypothetically, as the presidential campaigns ends in 2016, a new president’s fulfillment of promises to their constituents to address the nation’s affairs could further increase the deficit. With higher interest rate the crowding effect from government spending will crowd out investments (Mankiw, 2012).
Prior to the FOMC, many economists and financial professionals have expressed their predictions and expectations towards the outcome of the Feds’ decision in major news sources. CNBC asserts that an interest rate increase will upset the bull market, bond yields will climb (Cox J., 2015), meaning that investors would consider investing in money market products which are more secure (Financial Times, 2015). The Economist claims that the faster the economy allows for higher rates, the better it is for the economy through the transition of the business cycle. Conversely, an increase now would pointlessly risk recovery, due to the 3.7% annualized pace in the second quarter of 2015 (The Economist, 2015). Moreover, according to Koch & MacDonald 2014, the banking industry would face interest rates risk, due to the change in net interest income. Furthermore, as bond yields rise, bond prices decline affecting holders of long-term debt securities, since bond prices and yields are negatively related (Croushore, D, 2014). Also increasing payments of free-floating instruments affected by a rate hike, subsequently resulting in major balance sheet changes. Taking the Mundell-Fleming Model into account, a monetary contraction either from the discount rate, the FOMC operations, or changing the reserve requirement would shift LM curve upwards increasing interest rates, thus leading to an increase in net capital inflow, which would lead to dollar appreciation, as a result negatively effecting net export and output, ceteris paribus (Mankiew, 2013).
The Fed is in a peculiar era of monetary theory failure (WSJ, 2015). It has not yet settled its tug-of-war between price stability (2% inflation) and full employment (FRED, 2015). According to the FRB 2015, forecasted projections induce that interest rates increases have a slight chance of occurring in 2015 and a significant chance in 2016 (FRB2, 2015). Whether or not the Fed reaches their target objectives is still in question. On the other hand, continuing with negligible interest rates will still hinder the effects of monetary policy, particularly under the likelihood of a recession.
When the Fed raises rates, here’s what happens. Retrieved 17 September 2015, from http://www.cnbc.com/2015/09/15/when-the-fed-raises-rates-heres-what-happens.html (Cox, J. 2015)
Money & Banking 3 + Coursemate Printed Access Card. United States: South-Western College Publishing. (Croushore, D, 2014)
Federal Reserve Chair Janet Yellen held a news conference following the quarterly Federal Open Market Committee (FOMC) meeting on current economic projections. Retrieved 20 September 2015, from http://www.c-span.org/video/?328132-1/federal-reserve-chair-janet-yellen-news-conference (C-SPAN, 2015)
Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents Retrieved 18 September 2015 http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20150917.pdf (FRB2, 2015)
Press Release–Federal Reserve issues FOMC statement–September 17, 2015. Retrieved 18 September 2015, from http://www.federalreserve.gov/newsevents/press/monetary/20150917a.htm (FRB1, 2015)
False start. Retrieved 18 September 2015, from http://www.economist.com/news/leaders/21664137-fed-should-wait-until-inflation-closer-target-raising-rates-false-start (The Economist, 2015)
Fed Delays Interest-Rate Liftoff. Retrieved 18 September 2015, from http://www.wsj.com/articles/fed-leaves-interest-rates-unchanged-1442512974 (Hilsenrath, J, 2015)
Bank Management. United States: Cengage Learning. (Macdonald, S., & Koch, T. W 2014).
Mankiw, G. N. Macroeconomics (8th ed.). United States: Worth Publishers Inc.,U.S. (Mankiw 2012)
Trapped by Zero. Retrieved 18 September 2015, from http://www.wsj.com/articles/trapped-by-zero-1442358927?tesla=y (WSJ 2015)
Why is the Fed considering raising interest rates now? Retrieved from http://ig.ft.com/sites/when-rates-rise/#what-is-happening. (Financial Times 2015).
Retrieved 18 September 2015,Acquired from FRED https://research.stlouisfed.org/fred2/ (FRED, 2015)