July 31, 2019

Today, the Federal Reserve announced a decrease in the federal funds rate — the interest rate at which commercial banks lend to each other overnight — to between 2.0 and 2.25 percent, a decrease of a quarter point. The last time that the federal funds rate was reduced was on December 16, 2008, when the target was lowered to between 0 and 0.25 percent. For seven years, the Federal Reserve held the federal funds rate close to zero to help the economy recover from the 2008 financial crisis; it began increasing that target rate in December 2015. There were eight subsequent increases — the most recent one occurring in December 2018.

The Federal Reserve uses monetary policy to achieve its statutory mandate, which is to foster maximum employment, stable prices, and moderate long-term interest rates. Setting the target for the federal funds rate is therefore an important tool for the bank because that rate is the benchmark for Treasury bills and other short-term interest rates. Market expectations about those short-term rates, combined with other factors, affect the longer-term rates that are applied to consumer borrowing such as for mortgages or car loans and to business investment loans.

The loosening of monetary policy indicates a concern that the economy might be slowing down. The rate reduction is considered “insurance” against an end to the ongoing economic expansion. As the press release from the Federal Reserve stated, “in light of the implications of global developments for the economic outlook as well as muted inflation pressures, the Committee decided to lower the target range for the federal funds rate”.

The Federal Reserve had not reduced the federal funds rate since December 2008

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Lower interest rates are generally good news for debtors, but this year, the federal government will add around $1 trillion to the national debt. That borrowing offsets potential near-term savings from the lower rates and, while the future is uncertain, it is clear that interest costs will continue to become a larger and larger part of the federal budget as the debt grows.


Related: Economic Growth Slowed Significantly in Second Quarter — and is Projected to be Lower This Year Than Last


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