Yellen: Fed's Rate Increase Is Defensive

She explains Fed's big move
By Newser Editors and Wire Services
Posted Dec 16, 2015 3:00 PM CST
Federal Reserve Chair Janet Yellen answers a question during a news conference in Washington, Wednesday, Dec. 16, 2015, following an announcement that the Federal Reserve raised its key interest rate...   (Susan Walsh)
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(Newser) – After the Federal Reserve raised interest rates for the first time in nearly a decade, Fed Chair Janet Yellen stressed that the 0.25% rate hike was pre-emptive. Inflation still remains well below the central bank's 2% target, largely because of transitory factors such as falling oil prices. Yet the Fed made the move despite low inflation because its policies operate on a lag. This means that Yellen wanted to head off the risk of sharply higher inflation a year from now, rather than today. "It takes time for monetary policy actions to effect future economic outcomes," she said at a news conference. Yellen indicated that the hike was partially defensive. If rates stayed at near zero, the Fed might not have the tools to combat a recession. "We've worried about the fact that with interest rates at zero, we have less scope to respond to negative shocks," she said at a news conference.

When growth struggles, the Fed often cuts rates to help increase the amount of cash flowing through the economy. But by staying close to zero, the Fed would be unable to cut rates or it would be forced to have negative rates for the first time in its history. Fed officials hiked interest rates in response to seemingly robust 5% unemployment. But in addition to maximizing employment, the Fed is responsible for maintaining stable prices. Inflation remains below the Fed's 2% target. The statement by the central bank acknowledged the drag from declines in energy prices and decline in inflation expectations, even though it still expects to reach its target "over the medium term." The result is that any future rate hikes will be "gradual" and depend on further progress toward the inflation goal. Shortly after the Fed's rate announcement, major banks began announcing that they were raising their prime lending rate from 3.25% to 3.50%.

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