Today, the Federal Reserve announced another decrease in the target for the federal funds rate — the interest rate at which commercial banks lend to each other overnight — to between 1.75 and 2.00 percent. The action represents a decrease in the rate of a quarter point and is the second reduction this year; in July, the rate was lowered to between 2.00 and 2.25 percent. This year’s reductions reflect the central bank’s attempts to mitigate the effects of a global downturn, the ongoing trade war, and general economic uncertainty.
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 business investment loans and consumer borrowing for mortgages or car loans.
For 7 years after the financial crisis that began in 2008, the Federal Reserve held the federal funds rate close to zero to help the economy recover. It began increasing that target rate in December 2015; there were eight subsequent increases — the most recent one occurring in December 2018.
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, their decision “supports the Committee’s view that sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective are the most likely outcomes, but uncertainties about this outlook remain.”
Lower interest rates are generally good news for new borrowers, 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.
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