Fed Raises Key Rate Again(henderson, 2005), Which

¶ … Fed Raises Key Rate Again"(Henderson, 2005), which appeared in The Washington Post, outlines the reasons Federal Reserve officials recently implemented a short-term interest rate increase. The current federal funds rate stands at 4%, the highest level since 2001, and reflects a quarter percent increase. Furthermore, this raise is the twelfth consecutive one since June 2004 (Henderson, 2005) and is, as Federal Reserve officers note, only one in a series of anticipated increases. The next raise is likely to take place at the end of January 2006, bringing the federal funds rate to 4.5%. However, certain analysts expect increases in December. Some specialists claim a projected rate of 5.5% by July of next year, which they say will conclude the cycle of increases. Naturally, with Greenspan retiring at the end of January, the proposed raises are speculative as Bernanke has yet to demonstrate his intentions as the future Federal Reserve Chairman.

The new 4% federal funds rate brings the cumulative increase over the past 1.3 years to 3 percentage points. The last time this occurred was in the mid-1990s, which created economic havoc both domestically and abroad -- particularly in Mexico. However, such turmoil is not currently present in the economy. This is due to an important difference between current increases and those during the 1990s: the former were anticipated while the latter were mostly unexpected. The implication is that predictable interest rate raises are readily absorbed into the economy whereas unforeseen increases tend to distress it. Current conditions support this principle. Despite rising energy costs and interest rates, the economy continues to expand. Furthermore, the Commerce Department recently stated that the nation's GDP 'rose at a 3.8% annual rate in the third quarter after expanding at a 3.3% pace in the previous quarter' (Henderson, 2005, p.1). Certainly a nation's economic welfare benefits from anticipated and gradual interest rate increases.

That Federal Reserve officials plan to continue increasing interests rates was evident with their frank comment about their intentions to do so into the foreseeable future. More specifically, Greenspan mentioned a plan to increase rates at a measured pace (Henderson, 2005), which is expected to be raised one quarter percentage point per Federal Reserve committee meeting. Confidence in the Federal Reserve's statement is evident in the futures markets connected to federal funds rates, which anticipate and therefore have planned for a 4.5% (as mentioned above). Along with the current increase, subsequent raises are deemed low enough to check inflation while simultaneously capable of stimulating economic growth.

The increase in the federal funds rate obviously affects consumer and business loan rates. In fact, many banks subsequently raised their prime interest rates on business loans to 7%; the same is yet to be seen with consumer interest rates. What's more, interest rates on CDs and money market funds may also experience an increase (Henderson, 2005). With higher borrowing costs and more appealing incentives to save, it is seems rational to state that such changes will discourage inflation. Indeed, this was the main reason Federal Board members decided to raise the federal funds rate: to prevent escalating inflation. In other words, as consumers and businesses spend less money as a result of increased borrowing costs, demand correspondingly decreases, thereby discouraging businesses from raising prices.

An interesting economic phenomenon has unfolded. Recent unforeseen events, specifically hurricanes Katrina and Rita, have affected and are expected to affect the economy in two distinct ways. The hurricanes are initially and temporarily slowing down the economy but are expected to consequently spur it. As mentioned above, the former is largely due to higher energy costs while the latter will be a result of rebuilding efforts in the Gulf Coast region. This is a modified economic prediction as the original was less optimistic. Directly following the hurricanes, after acknowledging damage to the local oil industry and the associated rise in energy prices, analysts forecasted an economic slump. Furthermore, besides unemployment surges, they anticipated higher inflation as a result of consumer uncertainty. True to expectations and common sense, a half million workers filed for unemployment insurance after the hurricanes. However, employment opportunities were growing strongly in September throughout the nation, outside the affected region. What's more, energy prices have 'retreated from their post-hurricane highs' (Henderson, 2005, p. 2).