Tighter, Tighter: When Will Fed Increases Start to Pinch?

Network News

X Profile
View More Activity
By Nell Henderson
Washington Post Staff Writer
Thursday, June 29, 2006

The Federal Reserve is on track to lift its benchmark interest rate again today for a 17th consecutive quarter-percentage-point increase over 25 months, making this the longest sustained campaign on record of raising interest rates.

So why isn't the economy choking by now?

The short answer is that money is still pretty cheap, in historical terms. But Americans are finally starting to feel the squeeze, as higher borrowing costs cool the housing market, depress automobile sales and crimp some household spending.

The Fed started its recent streak of interest rate increases from an extraordinarily low level on June 30, 2004, when the nation's central bank nudged its benchmark rate up for the first time in a year, from a four-decade low of 1 percent.

Since then, Fed policymakers have raised their benchmark rate gradually, in quarter-percentage-point steps, signaling their intentions along the way so each bump caused barely a ripple in financial markets. Today's increase is likely to nudge the benchmark rate to 5.25 percent from 5 percent, just modestly above its long-term average after adjusting for inflation.

"Interest rates are sort of back to normal levels after being unusually low," said Ray Stone of Stone & McCarthy Research Associates.

Some interest rates remain low. The rate on 30-year, fixed-rate mortgages, for example, rose to 6.71 percent last week, according to Freddie Mac, the giant mortgage buyer. That's up from a recent low of 5.21 percent in June 2003 but nowhere near the double-digit rates of decades past.

"The Fed's action has not brought the economy to its knees," said Anthony Chan, chief economist in the private-client division of J.P. Morgan & Co.

The Fed directly controls the interest rate banks charge one another for overnight loans, a benchmark known as the federal funds rate. That rate indirectly influences borrowing costs throughout the economy. The central bank uses its influence over rates to try to keep the economy growing at a sustainable pace without igniting inflation. Tighter credit dampens spending, making it harder for businesses to raise prices. Easier money does the opposite.

In contrast to the campaign of the past 25 months, the Fed has previously acted much more aggressively, pushing interest rates much higher and much faster to battle hotter inflation -- and causing much more economic pain in the process.

Fed data on the federal funds rate go back to 1954. Until now, the longest stretch of rate increases lasted 24 months in 1977-79, with the rate peaking at 10 percent. That campaign was followed by a recession. If the Fed acts as expected today, this series of bumps will be the longest on record by one month.

When Paul A. Volcker became Fed chairman in 1979, both the inflation and the federal funds rate were 11 percent. He jacked the benchmark interest rate up to 19 percent in 1981, triggering the deepest recession since the Great Depression.


CONTINUED     1        >

© 2006 The Washington Post Company

Network News

X My Profile
View More Activity