TOPICS > Economy

The Federal Reserve Raises Interest Rates

June 30, 2004 at 12:00 AM EDT


GWEN IFILL: The Federal Reserve’s decision today to raise short-term interest rates by a quarter point was widely anticipated. In a statement, the Federal Open Market Committee suggested it may continue to raise rates “at a pace that is likely to be measured.” The Fed also made clear it is prepared to take more aggressive action if needed.

What does this change in monetary policy mean for you and for the economy? For that I’m joined by Philip Jefferson, professor of economics at Swarthmore College, and the president-elect of the National Economic Association. Welcome, professor.

PHILIP JEFFERSON: Thank you for having me, Gwen.

GWEN IFILL: The Boston Globe wrote that the era of cheap money is over. Is that true?

PHILIP JEFFERSON: I think it certainly is true. We’ve been through an extraordinary period these past four years. The Fed last increased interest rates in March of the year 2000 in an attempt to slow down the economy with respect to the technology bubble as well as in response to the Sept. 11 attacks. So what the Fed did then was to cut interest rates and in cutting interest rates they wanted to stimulate the economy. And so we’ve lived in a low interest rate environment now for about four years.

Today the Fed realized that it is time to change course because the economy has started to recover. We’ve had about — the creation of about 1.2 million new jobs this year and also there are signs that inflation is starting to pick up. So the Fed has been signaling throughout the beginning of the year that it’s time for a change in interest-rate policy and today we saw the first step to getting the economy on the — on a path of interest rate increases.

GWEN IFILL: We have been hearing these hints from Alan Greenspan and the Fed for some months now, that there would be a rate hike right about now. It wasn’t a big surprise. Does that mean perhaps that this was overdue?

PHILIP JEFFERSON: No, I don’t think it was overdue at all because the Fed had to wait until the labor market turned around. We have been in recovery for some time now, but yet the labor market was very sluggish. The economy was not creating jobs at a pace consistent with past post-World War II recoveries. So we just started to see some job creation in the fall of last year and the pace has quickened in the spring of this year. So they had to signal that some interest rate increases were in order, but at the same time wait until we started to get more robustness in the labor market.

GWEN IFILL: When people hear about interest rates going up, they think about two things mostly: Their credit cards and their mortgages. What affect will this quarter point increase have on those two things?

PHILIP JEFFERSON: Certainly if you have an adjustable rate mortgage it is going to increase in the coming months. Not only will it increase as a result of this quarter-point step that they took today, but they’ll there will be future increases and so that will cause for future increases in those adjustable rate mortgages also.

With respect to the credit card environment, many credit cards are linked to the prime interest rate. As a result of this change, many banks are going to increase the prime interest rate so we will see an adjustment in credit card rates also. So borrowing in general will become more expensive.

GWEN IFILL: What about fixed mortgages?

PHILIP JEFFERSON: Well, the fixed rate mortgages, if you’re already in a fixed rate mortgage you don’t have to worry about these interest rate adjustments. However, the new fixed rate mortgages will see higher rates as a result of the new path that the Federal Reserve board is on.

GWEN IFILL: How does rate increase like this affect savings?

PHILIP JEFFERSON: Well, if you are a saver and you have a traditional saving vehicle like a money market, mutual fund or if you have CDs or traditional savings accounts, then this move will actually increase the return on those savings. Now typically the types of households that have those types of accounts are senior citizens so if you’re a senior citizen and you have very traditional saving vehicles, then this is going to be good news for you.

GWEN IFILL: Alan Greenspan and many leading economists and even the Open Market Committee today have all alluded to their fears of inflation and the fact that that might just start gradually creating a bubble that they can’t reverse. How does increasing the interest rates put a curb on inflation?

PHILIP JEFFERSON: Well, it’s going to put a curb on inflation by slowing down borrowing. So if you were a household and you were thinking about buying a new refrigerator or a new stove, those are big-ticket items that require households to borrow. By making borrowing more expensive, you will slow down the rate of borrowing and slow down purchases on big durable goods. The same holds for firms also who have to borrow in order to make large purchases like tractors and things of that sort so this is going to slow down what we would call an investment demand on their part.

GWEN IFILL: Does an interest rate increase like this affect different socioeconomic groups differently.

PHILIP JEFFERSON: I think it’s certainly the case that the impact of these interest rate increases will fall differently on different groups. For example, when the economy slows we know that those with less educational attainment tend to bear the brunt of any slowdown. We have differences across demographic groups with respect to race. We have a situation where the unemployment rate for African-Americans is still around 9.9 percent, which is quite high. So it is an established fact that slowing of the economy will have a disproportionate effect on certain demographic groups.

GWEN IFILL: And, finally I guess the question becomes what happens next. The committee wrote today that in the future they will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability. What does that mean?

PHILIP JEFFERSON: What that means is that they will look at the inflation numbers over the coming months and quarters. And if it’s the case that the inflation numbers really start to accelerate, then they will act more swiftly than might otherwise be the case. So instead of seeing a series of steps of 25 basis points over the next two or three quarters, you might see some meetings in which interest rates will increase by 50 basis points. So the Fed is indicating that they are standing guard, they’re trying to signal to financial markets that they are aware that they’re forward- looking with regards to inflation and that they will be ready to act at the earliest signs.

GWEN IFILL: And that perhaps today’s increase is just the beginning of a series of future increases not the end.

PHILIP JEFFERSON: There’s no doubt that there will be a series of future — of interest rates increases in the very near future.

GWEN IFILL: Philip Jefferson, thank you very much for helps out.

PHILIP JEFFERSON: Thanks so much for having me, Gwen.