Facts about the Fed’s key rate

WASHINGTON: Markets have focused for months on the Federal Reserve’s plans for the benchmark federal funds target rate, parked near zero since the 2008 financial crisis.

Here are some facts about the key interest rate:

What is the federal funds rate? The federal funds rate is the Fed’s target rate for overnight loans between banks using their reserves held at the Fed.

Changes in it typically trigger a ripple through the economy, affecting short-term and long-term interest rates, the dollar’s foreign exchange rate and a host of other areas, including employment and consumer prices.

Why change the rate? The Fed can lower the rate to encourage spending and investment to boost the economy, and raise it to prevent overheating.

As inflation soared in 1979-1980, the Fed pushed the rate up to an eye-popping 20% to calm the economy. But that also sent the country into recession during the following two years.

After the economy slowed sharply in 2000 following the dot-com crash, the Fed steadily cut rates to stoke a return to growth. But in doing so it helped pump up the housing bubble that led to the 2008 crisis.

Why is the rate so low? When the US economy began to stall in 2007, the Fed slashed the rate in 10 steps from 4.75% in September 2007 to an unprecedented low level of 0-0.25% on Dec 16, 2008. The idea was to prevent a complete financial implosion.

It held the rate locked at the zero level as a way of getting the economy back to health after the deepest recession in eight decades. Now that the economy is growing steadily, many believe such a low rate is no longer warranted.

Zero pros and cons The ultra-low rate has made it easier for credit to flow through the economy. The loose policy has encouraged home buying and car purchases, helping both the housing sector and the auto industry recover.

On the downside, the bargain-basement rate has hurt people’s investments and savings, giving them next-to-nothing returns. It could also set the stage for inflation to come roaring back, a worry some Fed policy makers say justifies a higher rate.

What is normal? Fed policy-makers have made clear they want to move the rate back to “normal.” Their projections point to a rate of around 3% in two years, but that depends on the pace of growth and inflation. – AFP