The Fed Raised Interest Rates So What Happens Next?

Transcript

RENEE MONTAGNE, HOST:

The Federal Reserve raised interest rates last Wednesday, something it had not done since 2006, which had a lot of people concerned that the long-awaited move would roil the financial markets. It's been a few days now, so let's see what did happen and where to from here. We're joined, as we often are, by David Wessel. He's director of the Hutchins Center on Fiscal and Monetary Policy at the Brookings Institution and a contributing correspondent to The Wall Street Journal. Good morning.

DAVID WESSEL: Good morning, Renee.

MONTAGNE: So, David, the Fed raised the short-term interest rate. It had been holding near zero for years, just one quarter percentage point above zero. This was long-awaited, but then, finally they did it. Remind us of the immediate reaction.

WESSEL: Well, this move was so well-advertised by the Fed that much of the market reaction actually occurred in advance. It pretty much went as smoothly as the Fed could have hoped. Short-term interest rates, the ones over which the Fed has the most control, are moving up, so people are getting a little bit more money on their money market funds and paying little bit more money on their credit card loans.

Interestingly, the stock market had a great day on Wednesday after the Fed announcement and then it was terrible on Thursday and Friday. I think that's a reminder that the Fed isn't the only actor in this game. Bull market seems spooked by how fast oil prices are falling, and, now today, the markets will have to wrestle with the Spanish election, which suggests a lack of political support for the austerity program they've been running there.

MONTAGNE: And we heard a lot about - speaking of Spain - about the ripple effects this long-discussed move might have overseas, particularly in emerging markets. They weren't too happy, were they?

WESSEL: No. I mean, there's a lot of bad stuff going on in the economies of emerging markets, the big ones like South Africa, Brazil, Russia, China - much unrelated to the Fed. But basically, when the Fed raises U.S. rates, the value of the dollar goes up, and the value of other currencies tend to go down. The dollar's up about 10 percent on foreign exchange markets over the past year. Now, some countries like this, makes their exports more attractive. Europe is one. But others worry, with very good reason, that this could help create inflation in their countries that they don't want, or it could really shake up their banks or their companies that have borrowed in U.S. dollars.

So you see a divergence of reactions. In Mexico and Chile, they were very quick to raise their interest rates to match with the Fed did to cushion their currencies, but Taiwan cut rates and there's speculation that Canada, which is suffering from low oil prices, is about to do it - the same thing. So basically, nothing bad has happened, but it's still early days in this Fed tightening cycle.

MONTAGNE: And David, Janet Yellen is getting near the end of her second year as Fed chair. What have we learned about her?

WESSEL: Well, I think one thing we learned is she learned from her mistakes. In September when they didn't raise interest rates, she left everybody confused as to what the Fed's rationale was, so this time when they raised rates, she was very clear. She said we are raising interest rates because we anticipate inflation will rise over the coming months, and we want it moved gradually. If we wait, we'll have to have abrupt interest rate increases.

Two, she really, really prepares for these things. I mean, you could tell when the press asked her questions on Wednesday that she had written out the answers. And third, even more that predecessor Ben Bernanke, she's working very, very hard to build consensus. There were no dissents on the Fed policy committee even though we know there are some big disagreements about policy.

MONTAGNE: And just getting back to the practical aspect of interest rates, where do we see them going? Up some more?

WESSEL: Definitely up. Look, their new projections show that they expect to raise rates another full percentage point over the next year, provided the economy performs as they forecast, but they've left themselves a lot of wiggle room. And Jenny Yellen's press conference made clear that they will hold off on raising rates more if the economy stumbles or inflation fails to rise to their targets. But - sure looks we're going to get another increase or two and maybe four before this time next year.

MONTAGNE: David, thanks very much.

WESSEL: You're welcome.

MONTAGNE: David Wessel is director of the Hutchins Center on Fiscal and Monetary Policy at the Brookings Institution, and he's a contributing correspondent to The Wall Street Journal. Transcript provided by NPR, Copyright NPR.