The Federal Reserve has just announced a doubling of base interest rates, marking another step on the road to recovery from the 2008 financial crisis. The cost of borrowing has been at the historically low level of 0.25% since immediately after the crash, in a move aimed at stimulating recovery, but Fed chairwoman Janet Yellen today sounded a note of cautious optimism as she raised the rate to 0.5%.

In a detailed explanation of the committee’s thinking Yellen said the US economy “has come a long way” since the aftermath of the crisis, although it hasn’t quite reached where she would like it to be.

However with unemployment at 5% and falling the time to raise rates is now, she argues. It takes time for policy changes to work their way through the economy and if the Fed delayed this long-awaited decision any more there would be a risk of overheating. Right now inflation is lower than the 2% the government would like it to be at, but continued recovery with record low rates would risk it suddenly starting to rise. Yellen believes a modest rate rise now will avert that, less painfully than a larger increase in response to spiking prices.

Caution, warns Fed chief

Yellen warned journalists not to make too much of this move – it’s a small change and the fed funds rate is still incredibly low.

Before the crash it was running at 5.25%, and in the early 1980s it spiked to 20%, so borrowing is still cheap. Today’s move is a long way from a return to business as usual but it does signal increased confidence. As Yellen pointed out the US recovery is still vulnerable to shocks from overseas and domestic issues, but she now believes it’s strong enough to withstand them.

In the short term this move isn’t likely to have much impact on consumers; mortgage and personal credit should remain cheap. It looks to have dented confidence in some investments though, with gold quickly losing $9 on word of the announcement. Because precious metal investments don’t bear interest they become less attractive as interest rates rise, but today’s hike shouldn’t make much real difference.

Market confidence is a fickle thing, however, and perceptions can turn into real effects. Yellen seems to be hoping the move to a 0.5% base rate will be perceived as a vote of confidence in the US economy and its power of recovery.

Image by Day Donaldson and used under CC BY 2.0 license

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