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The Fed’s Decision and Why Interest Rates Rise

The United States Federal Reserve voted not to raise short-term interest rates at their September meeting, according to a press release issued last week.

While the labor market has continued to strengthen and the economic outlook has continued to improve, inflation has continued to run below the 2% benchmark set by the Federal Open Market Committee. This is partly attributable to low wage pressure caused by the flow of long-term unemployed back into the job market.

“Against this backdrop, the Committee decided to maintain the target range for the federal funds rate at 1/4 to 1/2 percent,” the press release states. “The Committee judges that the case for an increase in the federal funds rate has strengthened but decided, for the time being, to wait for further evidence of continued progress toward its objectives.”

While the Committee’s decision was to leave rates unchanged, several regional bank presidents dissented. Kansas City’s Esther George, Boston’s Eric Rosengren and Cleveland’s Loretta Mester wanted to raise interest rates. This is the first time since December 2014 that three officials have dissented.

With two more meetings scheduled before the end of 2016, it’s possible the Fed could choose to raise short-term interest rates before year’s end, so it’s important for brokers and borrowers alike to understand the basics of why rates rise and how the Fed goes about making this decision.

The rate of inflation is a crucial factor in the Fed’s decision. The higher the inflation rate, the more likely it is for interest rates to rise. This in turn causes lenders to charge higher interest rates in order to compensate for the decrease in purchasing power of the money to be repaid in the future. Additionally, the economic outlook, the job market and the unemployment rate all play a part in the Fed’s decision.

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