Fed Expected to Raise Rates

Dec. 13, 2005 — -- The Federal Reserve's Open Market Committee meets today and is expected to raise a key interest rate by a quarter point. If it happens -- and most economists expect it will -- the Fed funds rate will stand at 4.25 percent.

Just 18 months ago, the nation's consumers and businesses were enjoying a historic low 1 percent rate, which made borrowing money inexpensive.

Since then, the central bank has raised rates 12 times at a "measured" pace -- the phrase made famous in the committee's post-meeting statements. But today's post-meeting press release will be read with extreme interest by both economists and traders because they believe there will be a substantial change in language.

In the last several years, the governors have telegraphed their future interest rate intentions in the press release. Because interest rates are approaching a "neutral point" -- where they don't stimulate spending or cut it back -- most economists are looking for the Fed to stop hiking rates. That change in policy would be signaled in today's 2:15 p.m. release.

Why raise interest rates? The Federal Reserve increases interest rates to stimulate the economy or cool it down. Its key motivation is controlling inflation -- a role that Chairman Alan Greenspan and his named successor Ben Bernanke take very seriously.

Prices go up based on supply and demand. While the Fed has no control over supply -- that's the job of private sector businesses -- it can affect the demand side of the equation. By raising interest rates, the governors make it more expensive to borrow money. That gives pause to consumers and businesses that want to buy, as it will cost more to finance purchases. As demand drops, pressure to increase prices is reduced and inflation is diffused.

The Fed worried about the economic effects of the Sept. 11 attacks and quickly reduced rates in late 2001 to stimulate spending and keep the economy growing. Analysts say the Fed started raising rates in June 2004 to cool inflation. Now the governors are looking for a neutral point where growth is neither spurred higher or lower. Most economists believe this is somewhere between 3.5 percent and 4.5 percent.