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Fed says no to raising interest rates

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If you're thinking about applying for a new loan this year, it's a good time to do it. The Federal Reserve announced Wednesday that it would continue to leave today's record-low interest rates unchanged.

"The Fed believes that the economy is still in a very slow recovery and that the economy needs some additional stimulus in order to get itself out of this," says Ann Owen, a professor of economics at Hamilton College. Policymakers at the Federal Reserve hope that by keeping the federal funds rate at rock bottom for a longer period of time, businesses and consumers will be encouraged to ramp up their spending and take out new loans, which should, in turn, help pump up the U.S. economy.

"The Committee expects economic growth to remain moderate over coming quarters and then to pick up gradually," the Fed's Open Market Committee said in a post-meeting statement. "Consequently, the Committee anticipates that the unemployment rate will decline gradually toward levels that it judges to be consistent with its dual mandate."

The Fed's decision to keep rates low also means current borrowers with variable rate loans won't see a sudden rate hike any time soon. That's especially good news for credit card holders, since the majority of U.S. credit cards are variable rate cards. That means they are tied to the prime rate, which is typically 3 percentage points above the federal funds rate. When the federal funds rate is raised, the annual percentage rates (APRs) of variable rate loans go up as well.  

Consumers shouldn't wait to pay down their lingering debt, however, because they won't be off the hook forever, say experts. "In the very short term, I don't think people need to be concerned about interest rates increasing," says Owen. "But in the long term, it's almost certain that they will."

Consumers should also be aware that those rate hikes, when they do come, won't necessarily be small, she adds. When the Fed starts raising rates, it will eventually raise them by more than a few percentage points, she says, which will have a significant impact on the amount of interest people pay on their loans.

Fed: No rate hike for now
The Fed's announcement that it will leave short-term interest rates alone for now surprised no one. The Fed announced in January that it didn't expect to raise the federal funds rate until at least 2014.

The current federal funds rate -- which is near zero -- hasn't budged since 2008 when the economy went into a tailspin, and economists predict that the Fed will remain cautious about raising rates until economic growth is stronger. "Their estimates for GDP growth are subdued," says Paul Edelstein, director of financial economics at IHS Global Insight. They're optimistic, he says, but not enough to change course on short-term rates. "They don't see the unemployment rate going down very quickly," he adds, so they're reluctant to start tightening monetary policy (which, in economist-speak, means raising the federal funds rate, among other measures).      

That said, at least one voting member of the Federal Open Market Committee (FOMC), Jeffrey Lacker, has publicly advocated raising the federal funds rate sooner than 2014. "The logical time to raise rates is going to be sometime next year," said Lacker in an interview with Bloomberg Television. "That's based on my sense that growth is going to pick up enough by then in order to warrant raising rates to keep inflation pressures under control."

However, experts say that it would take extraordinary economic growth to prompt other voting members of the FOMC to advocate raising interest rates sooner than forecast. "Especially given that they've publicly stated a date or at least a range of a date, I think you have to see more unambiguous signs that the economy is recovering much more rapidly than they originally thought," says Hamilton College's Ann Owen.

The economy did show some encouraging signs in recent months, with employers adding more than 200,000 jobs per month several months in a row. However, employers only added 120,000 jobs in March, disappointing economists who expected much more robust gains. "There is a big question of whether the job growth we're seeing is sustainable," adds IHS Global Insight's Paul Edelstein. For example, he points out, there are a number of temporary factors that could account for the bigger-than-expected jobs gains, such as an unseasonably warm winter and employers overcompensating for mass layoffs during the recession.     

The other measure that could prompt policymakers to raise rates sooner than expected is if inflation begins to run above the current target rate of 2 percent. That's because the Federal Reserve has a dual mandate to promote full employment and make sure prices don't run amok. "They have to balance job growth with price stability," explains Edelstein. "Usually, when jobs are being created, that means inflation is going to accelerate and so they have to find the right balance."

It's important for consumers to realize, however, that the inflation indicators that the Fed looks at aren't necessarily the indicators that are written about in newspapers, such as food and gasoline prices. "The issue with looking at energy and food prices is they are very volatile," says Owen. Not only can price increases for food and energy be temporary, they are also largely out of the Fed's control. So the Fed instead tends to take those indicators out of consideration.

That's why even though energy prices are currently higher than the Fed would like, the Fed thinks the price increases are temporary and so isn't willing to act on those higher prices by raising interest rates, says Owen.

"One of the things that people need to keep in mind when they try to interpret what the Fed is doing is that monetary policy doesn't typically work right away. It takes a little bit of time to have an impact on the economy." So the Fed isn't going to make a change that may turn out to have been unnecessary several months down the line.

See related: Inflation is coming eventually; here's how it will hurt, Bankruptcy filings continue to slide, Consumer credit card balances drop for the second month in a row

Published: April 25, 2012


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