Federal Reserve Raises Interest Rates to Curb Economic Expansion

The Federal Reserve, the nation's central bank, raised two short-term interest rates by half a percentage point today, marking the sharpest increase in more than five years. This move is aimed at braking the nation's economic expansion before it feeds inflation and to protect the value of the dollar in international markets. In a statement, the Federal Reserve said that the action "substantially remove[s] the stimulus to the economy that low interest rates provided last year, and that top central bankers contend is no longer needed." The decision delighted Wall Street, with stock and bond prices shooting up, but dismayed Congressional Democrats and some business groups, who warned that the move could stall the economy and increase unemployment.

Key Takeaways:

• The Federal Reserve raised two short-term interest rates by half a percentage point, marking the sharpest increase in more than five years.
• The move is aimed at braking the nation's economic expansion before it feeds inflation and to protect the value of the dollar in international markets.
• The decision delighted Wall Street, with stock and bond prices shooting up, but dismayed Congressional Democrats and some business groups.
• The Fed raised its target for the interest rate that banks charge each other for overnight loans, known as the Federal funds rate, to 4.25 percent from 3.75 percent.
• The key discount rate was raised to 3.5 percent from 3 percent.
• The move is aimed at reducing long-term interest rates by cooling the economy and investor expectations about inflation.
• The Administration has shifted away from its aggressive pro-growth stance, now concerned about excessive growth and higher inflation.
• The Federal Reserve's statement said that the higher short-term interest rates were "designed to maintain favorable trends in inflation" and that the central bank's policy-setting Federal Open Market Committee had reached its goal of a neutral policy.
• Big commercial banks moved to translate the Federal Reserve's action into higher borrowing rates for consumers, increasing their prime rates by half a percentage point to 7.25 percent.
• The move is likely to benefit consumers through cheaper rates on loans like fixed-rate mortgages, if the Federal Reserve succeeds in its ultimate goal of reducing long-term interest rates.

Statistics:

• The Federal Reserve raised two short-term interest rates by half a percentage point, from 3.75 percent to 4.25 percent for the Federal funds rate and from 3 percent to 3.5 percent for the discount rate.
• The prime rate increased to 7.25 percent.
• The Dow Jones industrial average shot up 49.11 points, to 3,720.61.
• The yield on long-term Treasury bonds fell to 7.26 percent, down from 7.44 percent on Monday.
• Consumer prices rose only one-tenth of a percent in April, while producer prices fell a tenth of a percent.

Sources:

• The New York Times, May 23, 1994, Page D1.
• Interviews with top Federal Reserve officials, conducted over the last month.
• Statement by the Federal Reserve, May 23, 1994.
• Comments by President Clinton, Treasury Secretary Lloyd Bentsen, and White House Press Secretary Dee Dee Myers.