At the most recent Federal Open Market Committee (FOMC) meeting, the U.S. Federal Reserve raised its federal target funds for the first time since December 2018. The Fed has increased the target funds rate by 0.25%, bringing current rates into the range of 0.25%–0.50%, up a quarter-point from 0.00%–0.25%. This long-anticipated move is part of the Fed’s plan to curb inflation, which is surging at its highest level in 40 years.
Historic comparison
Annual inflation in the United States accelerated to 7.9% in February—its highest point in four decades, according to data from the Bureau of Labor Statistics.
For many leaders, this is the first time businesses are grappling with inflation in a generation. Starting from about 2 percent in the late 1960s, inflation rose to 12 percent in 1974 and 14.5 percent in 1980. The chairman of the Federal Reserve at the time, Paul Volcker, was brought in because of his hardline approach to inflation. He pushed interest rates to nearly 20%, throwing a cold bucket of water on the economy. The result was nearly instantaneous as people stopped buying, and unemployment rose over 10%—but by 1986, inflation was back down to 1%.
Of course, the Federal Reserve wants to avoid a sudden and drastic shift to the economy. By raising the federal target fund rates incrementally, they hope to slow the rapid rise of inflation without having a detrimental impact on the day-to-day lives of Americans.
Understanding the increase
As the central bank for the United States, the Federal Reserve is tasked with setting monetary policy to promote maximum employment, stable prices, and moderate long-term interest rates to support conditions for long-term economic growth. Banks and similar institutions then target this range when they lend overnight money to one another. They use these hyper-short-term loans to collectively maintain their required cash reserves, or to otherwise raise immediate operational cash.
Each bank operates independently and can choose when—or if—to lend to or borrow from other banks within the Fed’s current target rate range. Each also sets its own, public-facing retail rates.
When the Fed increases the target funds rate, it’s hoping to reduce the flow of excess cash or stimulus in the economy, which in turn can help temper inflation. Alternatively, when the Fed lowers the target funds rate (as it did during the pandemic and the Great Recession), it’s hoping to keep stimulating cash flowing through the economy without letting inflation get out of hand.
How other rates are affected
The Fed is in a relatively strong position to encourage long-term economic growth through its actions, but the results of this change are neither instantaneous nor all-encompassing. Often, the actions of the Fed will trickle down to other types of loans and move them in a similar direction for the same purpose. But given the complexity of the system and how it’s affected by the global market, any given move interacts with countless others with varied results.
Existing fixed-rate debt such as home and student loans may not be as immediately affected by rising rates, while free-floating credit card debt is more likely to creep quickly upward in tandem with the Fed’s rates. It’s generally wise to avoid credit card debt to begin with, given their persistently higher rates, but it’s even more critical as rates rise.
Similarly, you may or may not receive higher rates on interest-bearing instruments such as bonds, CDs, bank accounts, etc. That’s because it’s the banks and similar entities, not the Fed, who set these rates.