Fed Lifts Benchmark Interest Rate, as Expected

The increase, the first since 2018, is one of several planned for this year

Woman holding credit card and looking at laptop.
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The era of easy money is officially over. 

As widely expected, the Federal Reserve raised its benchmark interest rate from virtually zero Wednesday in the first hike since 2018. The increase—to a target range of 0.25%-0.50% from 0%-0.25%—is just the first of several planned this year and sets the stage for higher borrowing costs throughout the economy. 

Key Takeaways

  • As expected, the Federal Reserve raised its benchmark interest rate by a 0.25 percentage point. It’s been at virtually zero since the start of the pandemic.
  • Fed officials said it’s the first of many rate hikes planned this year and next. They now foresee the benchmark reaching 1.75%-2% this year, double what they previously anticipated. 
  • The central bank is raising borrowing costs to lower soaring inflation. Consumer prices haven’t risen this fast in 40 years.

The move is a major shift for the nation’s central bank, which had been keeping the benchmark fed funds rate at next to nothing since COVID-19 as a way of cushioning the economy from the fallout of lockdowns and job losses. 

But now it essentially wants to do the opposite: take that cushion or slack out of the economy in order to stem soaring inflation that the Fed said will likely be made worse by the Russian invasion of Ukraine. Raising the fed funds rate, which influences interest rates on credit cards, mortgages, and other loans, discourages borrowing by making it more expensive. That, in turn, should deter people from spending and cool inflation.

“We're fully committed to bringing inflation back down and also sustaining economic expansion,” Federal Reserve Chair Jerome Powell said during a virtual press conference after the committee’s meeting. “We do understand that these higher prices, no matter what the source, have real effects on people's well-being.”

The central bank has a tough balancing act because tamping down demand not only cools inflation, but can hurt the economy. That’s especially risky at a time when the economic fallout from the Russian invasion of Ukraine threatens to create a drag on growth. If things go wrong, we could get the worst of both worlds: a slowing economy and high inflation, a phenomenon known as stagflation.

A Bigger Increase This Year and Next

Wednesday’s rate hike in and of itself is unlikely to have a big impact on most consumer loans—the bump only adds about $3 a month to a typical car loan, for example—but Fed officials now expect to raise the rate by another 1.5 percentage points over the course of this year—far more than they expected to in December and more than many economists had forecast. In 2023 and 2024, they expect to have the range set at 2.75%-3%, a level we last saw in 2008. 

That means people considering major purchases like a house, might want to pull the trigger sooner rather than later, said Jaime Quiros, a financial planner for FBB Capital Partners. 

The central bank’s Federal Open Market Committee is playing catch-up in some sense. It’s tasked with keeping unemployment low and inflation under control, and while it’s succeeded at its first goal, it’s missed the mark on its second. The unemployment rate in February was down to 3.8%, just a touch above pre-pandemic levels, but the inflation rate was 7.9%, the highest it’s been since 1982.

Besides pivoting on interest rates, the committee is looking to reverse its large-scale purchases of financial assets, another tool it had used to support the economy. Powell said the committee could begin reducing its holdings of Treasury and mortgage-backed securities as soon as its next meeting in May.

Have a question, comment, or story to share? You can reach Diccon at dhyatt@thebalance.com.

Article Sources

  1. Federal Reserve. “Federal Reserve Issues FOMC Statement.”

  2. Federal Reserve. “Summary of Economic Projections.” Page 2.

  3. Federal Reserve. “Open Market Operations.”