Federal Reserve Chair Janet Yellen says raising interest rates marks the end of a lengthy debate about whether the economy was strong enough to withstand higher borrowing costs. (Reuters)

The Federal Reserve launched a new campaign on Wednesday to raise interest rates and return the American economy back to normal, with officials expressing confidence that they will be able to wean the nation off cheap credit without derailing the recovery.

In a unanimous vote, the central bank moved its benchmark interest rate up by one quarter of a percentage point — a tiny increase but the first since the Fed slashed rates to zero seven years ago in an unprecedented effort to stanch the financial crisis. Wednesday’s decision reflected officials’ faith in the resilience of the recovery, and Wall Street surged after the announcement, with the Dow Jones Industrial Average climbing 224 points, or 1.28 percent, to 17,749.

“The underlying health of the U.S. economy, I consider to be quite sound,” Fed Chair Janet Yellen said in a news conference Wednesday.

For ordinary households, the Fed’s decision likely means that the cost of mortgages, auto loans and credits cards will start to creep higher, particularly if the central bank raises its target rate even more over the next year.

But the Fed gave no precise timeline for its next move and pledged to withdraw its support for the recovery gradually. Some analysts believe the central bank will instead be forced to reverse course. The country’s economic expansion has been dogged by volatile oil prices, a slowdown in China and weak global growth, and the Fed’s cautious approach is an acknowledgement that it is operating in uncharted territory and further progress is not guaranteed.


“It’s been a long time since the Federal Reserve has raised interest rates,” Yellen said. “I think it’s prudent to be able to watch what the impact is on financial conditions and spending in the economy.”

The last time the Fed hiked the rate was in 2006 — before the iPhone was introduced. Many of the young adults hunting for their first homes or staffing Wall Street’s trading desks have never experienced a rate increase, and it remains to be seen how they will adjust to this new environment.

The central bank’s vote Wednesday technically sets a range of one-quarter to one-half of a percent for its influential rate. In addition, the Fed is using complex new financial tools to implement the rate hike, creating another layer of uncertainty.

“I think it’s very hard to predict just how forcefully they’ll need to use these tools,” said Don Kohn, former vice chairman at the Fed and now a senior fellow at the Brookings Institution. “They’ll have to figure it out as they go along.””

The move could spell the end of the rock-bottom rates on mortgages that spurred a refinancing boom and supported higher home prices. The cost of an auto loan is also expected to rise, dimming one of the brightest spots in the economy. One recent analysis predicted a one-percentage-point increase in interest rates could slow car sales by more than 3 percent.

Savers, however, may finally start to feel some relief after years of meager returns on investments in safe assets such as certificates of deposits and money market funds. Still, analysts cautioned that any improvement would likely be slow.

Returns “may not improve quickly enough from the perspective of those individuals who have already suffered through more than a half decade of historically low, and often inadequate, fixed income yields,” said Michael Thompson, chairman of S&P Investment Advisory Services.

The unemployment rate has fallen by half since peaking at 10 percent in the aftermath of the Great Recession. Official forecasts released Wednesday show the Fed believes it will drop to a median of 4.7 percent next year before leveling off. The economy has added jobs for 69 consecutive months, the longest streak on record.

Meanwhile, the broadest measure of the economy’s health -- the pace of the expansion -- has clocked in around 2 percent in recent years, a solid, albeit unspectacular, pace. Officials predicted it would pick up to a median of 2.4 percent in 2016.

“This action marks the end of an extraordinary seven-year period,” Yellen said. “The economic recovery has clearly come a long way, although it is not yet complete.”

Indeed, the pace of economic expansion remains significantly slower than it was before the financial crisis. Wage growth has been stagnant, and many unemployed workers have given up hope of ever finding a job.

But Fed officials believe rectifying those problems is the responsibility of lawmakers in Washington, not monetary policymakers. In the aftermath of the financial crisis, the central bank often expressed frustration with the political gridlock that led to across-the-board federal spending cuts, a government shutdown and the threat of breaching the nation’s debt limit. The ensuing economic damage made the Fed reluctant to withdraw its support sooner.

At the same time, lawmakers have ramped up criticism of the Fed as it tested the boundaries of its powers. In addition to cutting its target rate to zero, the Fed pumped roughly $3.5 trillion into the economy, buying up long-term Treasuries and mortgage-backed securities. House Republicans passed a bill last month that attempts to rein in the central bank by requiring it to follow prescribed rules for setting interest rates and explain why when it doesn’t.

“Unsustainably low interest rates clearly didn’t solve the problem or else Americans today wouldn’t be stuck in the slowest, worst-performing economic recovery of our lifetimes,” Rep. Jeb Hensarling (R-Tex.), who heads the House Financial Services Committee, said on Wednesday.

On the other side of the aisle, some Democrats are now worried the Fed is moving too soon. Rep. John Conyers Jr. (D-Mich.) is sponsoring a proposal that would make reaching a jobless rate of 4 percent one of the Fed’s core goals.

“It is unacceptable for any branch of government to take any action to slow our economy before all Americans have the opportunity to experience the jobs recovery and meaningful wage growth,” he said in a statement.

Timing the first rate hike has been fraught with peril, and the Fed has repeatedly pushed back the goal post as the recovery failed to deliver.

Within the central bank, its 17 top officials were divided for much of the year. Richmond Fed President Jeffrey Lacker and Cleveland Fed President Loretta Mester were ready to hike as early as this summer. But two members of the Fed’s Washington-based board of governors, Lael Brainard and Dan Tarullo, along with Chicago Fed President Charles Evans, argued for waiting until 2016.

On Wednesday, Yellen argued that the Fed’s actions take time to soak into the economy. Further delay could cause the recovery to overheat and result in an abrupt rate hike that would increase the risk of an inadvertent recession, she said. Yellen emphasized that moving gradually to increase rates means that “the stance of monetary policy remains accommodative.”

Yellen has said the Fed will consider both “realized and expected” movements on inflation, the labor market and financial and international developments in deciding when to make its next moves. But she refrained from providing specific metrics that would tip the central bank into action.

“I’m not going to give you a simple formula for what we need to see on the inflation front in order to raise rates again,” she told reporters.

Fed officials Wednesday projected the benchmark rate would rise to a median of 1.4 percent by the end of 2016, suggesting a hike at every other meeting next year. The forecast for the following two years dipped slightly from what the central bank had predicted in the fall. The estimate of its target rate dropped from 2.6 to 2.4 percent in 2017 and from 3.4 to 3.3 percent in 2018.

Economists, including those inside the central bank, are debating whether rates will ever return to the their pre-crisis levels. The Fed’s forecasts show officials believe rates will eventually rise to 3.5 percent, below the historical norm of 4 percent.

“This really isn’t an end. It’s a beginning,” said Tim Duy, a former Treasury official and economics professor at the University of Oregon. “We got into this. Now how are we going to get out?”

Correction: An earlier version of this post misspelled Dan Tarullo's name.