Interest Rates Chapter 6 Drew Angerer/Bloomberg/Getty Images The Fed Contemplates an Increase in Interest Rates as the U.S. Economy Shows Signs of a Strong Rebound To keep the economy afloat after the financial crisis of 2008–2009, the Federal Reserve established extremely low interest rates. The hope was that the lower cost of capital would encourage business investment, help repair a damaged housing market, and prop up stock and bond markets, all of which would help stimulate the overall economy. Looking back, after the crisis, it appears that policymakers successfully kept the economy from immediately collapsing, but the economy was still weak, and unemployment remained stubbornly high. In response to the economy’s continued sluggishness, the Federal Reserve redoubled its efforts to strengthen the economy with its policy of “quantitative easing.” Through this policy, the Fed has systematically purchased large amounts of longer-term financial assets from leading financial institutions. The Fed pays for these assets by injecting new funds into the economy, which helps put downward pressure on interest rates. In December 2012, the Federal Reserve announced that it would maintain this policy until the unemployment rate fell below 6.5% or the inflation rate rose above 2.5%. As a result of their actions, the 10-year Treasury rate was pushed below 2%, and shorter-term Treasury rates were close to zero. Six months later, as the economy began to show limited signs of life, there were concerns that the Federal Reserve’s stimulative policies would eventually trigger a rise in inflation. Trying to maintain a delicate balance, the Fed reaffirmed its policy of quantitative easing. However, the Federal Reserve also suggested that in the months ahead it might “taper” its aggressive bond-buying program. In early 2014, Janet Yellen succeeded Ben Bernanke as Chair of the Federal Reserve, and Copyright 2019 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. WCN 02-200-203 Copyright 2019 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part. Due to electronic rights, some third party content may be suppressed from the eBook and/or eChapter(s). Editorial review has deemed that any suppressed content does not materially affect the overall learning experience. Cengage Learning reserves the right to remove additional content at any time if subsequent rights restrictions require it. Chapter 6 Interest Rates immediately supported the Fed’s balancing act. In her first major set of speeches, Yellen indicated that the Fed would continue to slowly taper its bond purchases. But she also indicated that, given the economy’s continued lack of robustness, the Fed would be in no hurry to take any active steps to raise interest rates until the economy had shown signs of steady improvement. Over the next year and a half, the economy showed signs of slow improvement, but the Fed resisted raising rates until December 2015. In arguing against rate hikes, many Fed leaders pointed out that despite improvement, the economy was still far from robust and that there were few signs of rising inflation. However, other policymakers promoted rate increases, arguing that it was important to restore a “normal” rate environment and to respond before inflation increased. More recently, a month after the 2016 election, the Fed once again raised their shortterm interest rate target. Perhaps more importantly, they also announced tentative plans to hike rates three more times in 2017. Responding to the news, stock and bond markets fell sharply.
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