By Xhaxany Cuellar, Editor in Chief
The Federal Reserve lowered its benchmark interest rates Friday, Sept.18 by 0.50% as it shifted from fighting inflation with a tightening policy to promoting spending with an expansionary monetary policy. The intent of the policy shift is the hope that households and businesses will respond by borrowing more to purchase capital goods or invest in their businesses.
This is the first rate cut in four years, bringing the federal interest rate into a new range of 4.75%—5%.
Dr. Danny Taylor, a professor of Economics at the University of Mary Hardin-Baylor, elaborated on the federal fund rate: “A more understandable term is the overnight rate because this is the overnight rate that banks charge other banks. We live in a 24/7 world, and if banks have liquid assets that they could lend out overnight, well, then they want to do that.”
The current inflation rate for 2024 is 3.2%, a rate that has slowly been decreasing. The Federal Open Market Committee seeks maximum employment and an inflation rate of 2%, a decision that comes after months of reducing inflation in an attempt to cushion the economy from slowing down further.
“The spike in inflation was caused by a combination of things, not just one thing, but they think they've brought inflation pretty much under control,” Taylor said. “To bring it any lower, would risk the unemployment rate going up more than anyone would like to see.”
Inflation and unemployment move in opposite direction of each other. The FED has signaled they are comfortable with where inflation is today but are worried about the unemployment rate, which is currently 4.2% in 2024; an ideal rate of unemployment would be 3%.
According to Dr. Paul Stock, an economic professor at the University of Mary-Hardin Baylor, “The labor market isn't really stable right now. The last labor report wasn't good, and so they're more worried about the unemployment rate right now than any inflation. So that's why they did this shift.”
The committee will continue reducing its holdings in treasury securities agency debt, and agency backed mortgages, meaning the government is going to sell what they have which will lower the money supply in the economy. Stock explained why,“They want to stabilize it, they feel that the supply is too large in the economy, and they're trying to reduce it.” Additionally, Dr. Stock discussed the reduction in holding of mortgage backed securities, “A mortgage backed security is when banks take a large group of home loans that they have and bundle them. A home loan is where someone has promised to pay the bank so much a month for 30 years or 20 years, depending how long the home loan is. That's a stream of income right there for the bank.
“They bundle all these home mortgages together and sell it as a bundle, as an investment. But they know some of those will default; there's a default rate. It's usually around 2% of the home loans will default, meaning those people will stop paying their own loans, and they foreclose on our house, but it's relatively low”
The committee is prepared to adjust its stance on monetary policy if risks emerge that could affect its goals. Some of the risks associated are the potential hazards that inflation could go back up rather than down and the risks that those saving or investing will move their money overseas to see higher returns on investments. This would result in the U.S. economy losing money to foreign investments overseas.
Whether to FED has cut interest rates too much or not enough remains a debate amongst economists.
