If you’ve been holding off on buying a new car or refinancing your mortgage, don’t worry. You’ve still got plenty of time to lock in today’s record low rates. The Federal Reserve announced Thursday that it will continue to leave the federal funds rate target at rock bottom — and it’s unlikely to raise the federal funds rate until mid-2015.
“Information received since the Federal Open Market Committee met in August suggests that economic activity has continued to expand at a moderate pace in recent months. Growth in employment has been slow, and the unemployment rate remains elevated,” said the Fed in a post-meeting statement. “Household spending has continued to advance, but growth in business fixed investment appears to have slowed. The housing sector has shown some further signs of improvement, albeit from a depressed level. Inflation has been subdued, although the prices of some key commodities have increased recently. Longer-term inflation expectations have remained stable.”
As a result of the weak economic data and the stable outlook for inflation, members of the Federal Reserve Open Market Committee voted to keep the federal funds rate target — which helps set the interest rate at which banks trade balances held at the Federal Reserve — at 0 percent to 0.25 percent.
In addition, committee members decided to extend the date at which they expect to raise the federal funds rate target from late 2014 to mid-2015. That move was part of a broader economy-boosting action that included buying monthly rounds of mortgage-backed securities at a rate of $40 billion per month until the labor market substantially improves.
“The Committee is concerned that, without further policy accommodation, economic growth might not be strong enough to generate sustained improvement in labor market conditions,” said the Fed.
The Fed’s decision to keep rates low for a few more years is good news for high-interest borrowers, such as credit card holders, who are continuing to pay down their existing balances. That’s because most credit cards in the United States, as well as other types of variable rate loans such as mortgages and auto loans, are tied to the prime rate, which is typically 3 percentage points above the federal funds rate.
When the federal funds rate target is raised or lowered by the Federal Reserve, the prime rate moves as well. When that happens, borrowers’ interest rates immediately go up or down in tandem with the prime rate.
Rates to remain low until at least 2015
The Fed hopes that by keeping the federal funds rate target near zero for several more years, lenders that tie their loans to the prime rate will keep the interest rates they charge new borrowers attractively low as well, says Ann Owen, a professor of economics at Hamilton College.
The Fed is signaling to people that we’re not done yet. That could have an effect on confidence, which could have a bigger impact on the economy than any small change in interest rates.
|— Ann Owen |
For example, the thinking goes, if you’re a lender who is considering approving a customer for a long-term loan, “you’re going to be comfortable charging a lower interest rate because you believe that interest rates won’t rise over a longer period of time,” says Owen.
Consumers, in turn, are more likely to borrow at lower rates. “The argument for the lower interest rates is that it does pull down borrowing costs for anybody out there who has a loan based on short-term interest rates,” says David Ely, a professor of finance at San Diego State University. “So, at least indirectly, it should boost the economy,” he says, because it encourages people to spend when credit is relatively cheap.
The problem, however, is that consumers and businesses don’t yet have the appetite to borrow huge amounts, say experts. “They’re not trying to borrow more; they’re trying to borrow less,” says Jim Johannes, director of the Puelicher Center for Banking Education at the University of Wisconsin.
“There’s a lack of demand that’s driving this,” adds San Diego State University’s David Ely. If you ask banks, “they would say that loan demand is quite low right now, and they don’t see a turnaround of that in a dramatic way,” he says.
Consumers, especially, have been steadily paying down their debt loads since the Great Recession and although they’ve increased the amount they borrow somewhat in the past year, they haven’t shown any signs that they’re ready to borrow as much as the economy needs to spark a robust recovery.
“A lot of consumers are deleveraging right now,” says Johannes. The lower rates are helping them to deleverage faster by allowing them to refinance some of their loans, such as their mortgages, he says. However, the cheap access to credit isn’t spurring consumers to spend the way the Fed hoped it would.
Businesses, in turn, are sitting on their profits, rather than investing money in new supplies or new workers, say experts, because they don’t have a steady enough customer base to justify the extra expense. “If you talk to businesses, they don’t say we don’t have enough credit. The problem is we don’t have enough customers,” says Rebel Cole, a professor of finance at DePaul University.
“There’s a general paralysis that the Fed is fighting,” adds Johannes. “People and businesses, they’re just saying, ‘I don’t know what’s going to happen and so what I’m going to do is I’m going to try to preserve the capital I have now.'”
Since January 2012, revolving debt, which is mostly made up of credit card debt, has fallen five months out of seven, according to research from the Federal Reserve. Total consumer credit, meanwhile, fell in July for the first time in 11 months.
Economists say that the drop in debt is a strong sign that consumers and businesses just aren’t ready yet to spend more than they can afford to quickly repay — and that’s dragging down the economy’s growth.
“If the economy is going to recover, consumer spending is going to be an important factor and although it’s growing, it’s not growing as fast as it needs to really support a robust recovery,” says Hamilton College’s Ann Owen.
That, in turn, is partially why the Federal Reserve has decided to extend the amount of time it plans to keep the federal funds rate target at rock bottom. It’s all about expectations, says Owen.
By extending the forecast, the Fed is sending a signal to consumers and investors that short-term interest rates will remain low for a while, so if they’re thinking about investing in a new car or in additional personnel for their small business, they still have time to do it.
“The Fed is signaling to people that we’re not done yet,” says Owen. “That could have an effect on confidence, which could have a bigger impact on the economy than any small change in interest rates.”
If you talk to businesses, they don’t say we don’t have enough credit. The problem is we don’t have enough customers.
|— Rebel Cole |
A difficult task
Many economists, however, are doubtful that the Fed’s efforts will have much of an effect. “In general, the Fed is very good under normal conditions at handling cyclical fluctuations in the economy,” says the University of Wisconsin’s Jim Johannes. However, the problems with the economy today are largely structural, he says, and there’s nothing the Fed can do about them.
“The frustration with the Federal Reserve is they’ve done about everything in their policy toolkit to fight the cyclical factors,” says Johannes. However, “the Fed is not equipped to fight structural issues,” such as state and federal budget deficits.
That said, “monetary policy is the only game in town,” says San Diego State University’s Ely. The U.S. government is extremely unlikely to invest federal funds into stimulating the economy and so the Fed is trying to do what it can and show that it’s not just sitting on its hands.