Question

2. This question refers to the article:

Fed raises interest rates, signals 2 more hikes in 2018

Akin Oyedele

Mar. 21, 2018, 2:00 PM

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    The Federal Reserve announced Wednesday that it raised its benchmark interest rate by 25 basis points, to a range of 1.50% to 1.75%.

    Over the next few weeks, this increase will affect credit cards, adjustable-rate mortgages, car loans, and other credit lines that don't have fixed rates.

    The Fed still expects to hike rates three times this year, but raised its projections for 2019 and 2020, citing a solid economic outlook. The Federal Reserve on Wednesday announced it would raise interest rates and steepened its outlook for hikes in 2019 and 2020.

After a two-day meeting, the Federal Open Market Committee unanimously voted to increase its benchmark fed funds rate by 25 basis points, to a range of 1.50% to 1.75%. It was the sixth rate increase since late 2015, as the US's central bank backed further away from emergency policies that helped heal the economy after the Great Recession a decade ago.

Over the next few weeks, this increase will affect credit cards, adjustable-rate mortgages, car loans, and other credit lines that don't have fixed rates. Savers could also earn higher interest on their accounts, though banks have been sluggish about keeping up with Fed hikes.

"The economic outlook has strengthened in recent months," the statement said. "The committee expects that, with further gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace in the medium term and labor market conditions will remain strong."

The Fed signaled two more rate hikes in 2018 amid speculation that it was considering adding a third increase to its projections. But it raised its forecasts for hikes in 2019 and 2020, citing a stronger outlook on the economy.

"I think we could easily go to four, because if you look at the dot plot, all they needed was one more person to up their estimate," said Dan North, the chief economist at Euler Hermes North America, referring to the chart of FOMC members' forecasts.

"I think by the time we get to the end of the year, we're more likely than not to get four," he told Business Insider.

A first for Jerome Powell

This week's meetings and press conference were the first for the new Fed chairman, Jerome Powell. Powell had quite a dramatic first day on the job. That day, February 5, the Dow Jones industrial average had its biggest-ever point drop after an unexpected jump in wages signaled that inflation was surging. The data was eventually revised lower. And in later congressional testimony, Powell said there was little evidence that inflation was accelerating. But it's now more crucial that the Fed doesn't make a policy misstep. Hike too quickly, and you choke demand for borrowing and spending. Move too slowly, and the economy can overheat.

The Fed raised its projection for economic growth this year. Many investors expected an upgrade, since the GOP approved major fiscal stimuli through $1.5 trillion in tax cuts and $300 billion in additional government spending. But the forecast for inflation this year was left unchanged.

"In theory, if you have lower unemployment, you should have higher inflation," North said, adding that "we haven't seen that in this recovery" for reasons including weak productivity growth.

Here's the Fed's full statement:

Information received since the Federal Open Market Committee met in January indicates that the labor market has continued to strengthen and that economic activity has been rising at a moderate rate. Job gains have been strong in recent months, and the unemployment rate has stayed low. Recent data suggest that growth rates of household spending and business fixed investment have moderated from their strong fourth-quarter readings. On a 12-month basis, both overall inflation and inflation for items other than food and energy have continued to run below 2 percent. Market-based measures of inflation compensation have increased in recent months but remain low; survey-based measures of longer-term inflation expectations are little changed, on balance.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The economic outlook has strengthened in recent months. The Committee expects that, with further gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace in the medium term and labor market conditions will remain strong. Inflation on a 12-month basis is expected to move up in coming months and to stabilize around the Committee's 2 percent objective over the medium term. Near-term risks to the economic outlook appear roughly balanced, but the Committee is monitoring inflation developments closely.

In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 1-1/2 to 1-3/4 percent. The stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained return to 2 percent inflation.

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant further gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.

a) Explain the monetary tool the FED likely used to enact the interest rate change described in the article. Include a picture of the money market as part of your explanation. (2 points)

b) Based on various things stated in the article, draw a picture of the AD, SRAS and LRAS to indicate where the FED believes the economy would head without the monetary policy they have enacted, and explain why, in this situation, the monetary policy undertaken will be helpful. (2 points)

Answer 1

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