Janet Yellen Prepares to Take the Training Wheels Off the U.S. Economy

It’s rare that a meeting of the U.S. Federal Reserve’s wonkish Federal Open Market Committee, which sets U.S. interest rates, can be considered historic. But that will be the case Wednesday, when Fed chief Janet Yellen is widely expected to raise the cost of borrowing in the United States for the first time in a decade, shedding one of the last vestiges of the the Great Recession.

The Fed hasn’t raised American interest rates since 2006, and they’ve been near zero since 2008. The reason for this is simple: The United States wanted to make the cost of cash dirt cheap as an incentive for consumers and investors to borrow money. That, in turn, spurred economic growth, allowing the United States to emerge from the global economic slowdown that began in 2008.

The Fed strategy worked; the U.S. economy is growing modestly — the World Bank expects it to grow by 2.7 percent this year — and the unemployment rate is at 5 percent, down from 10 percent at the depths of the recession in October 2009. Now, Wall Street analysts, Fed watchers, and futures markets alike overwhelmingly believe this free ride will end Wednesday; CME Group’s FedWatch Tool put the probability of a half-percent rate hike at 81 percent as of 4:30 p.m. ET Tuesday. The increase has been expected since March 2015, and Yellen hinted earlier this month it is likely to come Wednesday afternoon.

The two-day Fed meeting began Tuesday.

The zero-interest-rate policy is one of the last major programs the federal government used to rescue the U.S. economy after the 2008 collapse of Lehman Brothers put the global financial order in serious peril. After Lehman’s fall, the Treasury Department forced other U.S. banks to borrow billions of dollars to shore up finances, which were shaky after the collapse of the American housing market. In November 2008, the Fed began a process known as quantitative easing, which, over the years, inserted $3.5 trillion into the U.S. economy. That plan ended in October 2014.

The impact of the expected rate hike won’t be felt by consumers immediately, because it likely will be between .25 and .50 percent. But according to Robert R. Johnson, president and CEO of the American College of Financial Services, it’s an important symbolic step that shows confidence by the U.S. central bank.

“The Fed has been very measured, has been very patient, in making sure that they believe an increase won’t forestall the economic recovery,” Johnson told Foreign Policy. “I think that they’ve done that.”

It’s also a sign the Fed believes the threat of spillover from the global economic slowdown, as well as lingering financial crises around the world, has lessened. This summer, Greece teetered on the edge of bankruptcy and the Shanghai Composite Index dropped 40 percent as part of a broader Chinese slowdown. Minutes from the Fed’s June 16-17 policy-setting committee meeting indicated it wasn’t ready to raise interest rates because of fears of contagion from China and Greece. In July, September, and again in October, Yellen kept the rates near zero.

“Some of the Greece and China fears, it seemed like there was a crisis du jour,” Johnson said. “The Fed believes the world economy is stable enough that this long-awaited rate increase can take place.”

Others aren’t so sure. David Wessel, director of the Hutchins Center on Fiscal and Monetary Policy at the Brookings Institute, told FP he understands the argument for raising rates. But he still thinks it’s too early.

“I have no sympathy for the view that the Fed should have done this earlier,” he said. “What’s the rush? The risks of waiting are much smaller than the risks of moving prematurely.”

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