The Federal Reserve Board again held off raising its benchmark federal funds rate on Thursday, citing less than desirable economic circumstances.
The stance is an acknowledgement that the economy is doing okay, but it's not firing on all cylinders. That's essentially what the central bank would like to see before it raises its key rate. The weakness of the world economy is also a central factor in leaving interest rates where they are. And that means small business owners can relax, for the time being, with the knowledge that the cost of loans, for everything from credit cards to lines of credit, will stay the same.
The Fed left unchanged its federal funds rate, also known as the interbank lending rate, which is used by financial institutions to set the prime rate, or the base rate upon which other interest rates are set. The interbank rate has been at its lowest level, near zero percent, for the longest period in the history of the Fed.
"Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term," the Fed's Board of Governors said in a statement.
Behind Recent Rate Moves
The Fed, which is tasked with maintaining price stability and optimal employment, said it would like to see core inflation at a rate closer to 2 percent. Core inflation is currently running at about 1.8 percent, according to the Bureau of Labor Statistics. That indicator can represent sluggish consumer demand, which could be a result of stagnant wage growth and uncertainty in the job market.
And although the Fed is not supposed to consider economic events in other countries, according to its mandate, recent events overseas, specifically in China, are keeping the economy's recovery growing at a tepid pace. In August, China devalued its currency by three percent, which put global markets in a rout, and caused the Dow to drop momentarily 1,000 points in a single day, before closing down nearly 600 points.
With the onset of the financial crisis in 2008, the central bank pulled all levers possible to energize the economy. It first decreased the federal funds rate to near zero percent to stimulate lending and increase spending. The central bank then embarked on a program called quantitative easing, purchasing U.S. Treasuries in an attempt to make other assets, primarily stocks, more expensive. That move also beefed up the supply of money in the system, and further depressed interest rates.
Those maneuvers seem to have worked, with the stock market--in particular tech stocks--venturing into record territory for much of 2015. U.S. exchanges only recently ended a six-year bull market, dropping 11 percent in August when China announced it was devaluing its currency.
Why the Holdup
Things for small business owners are good but they're not great. Numerous economic reports on the state of small business show that entrepreneurs have greater access to capital than during the scary years of the recession when credit markets froze over and banks essentially closed their doors. Small business surveys suggest a stable percentage of businesses are funding operations from free cash flow, as opposed to loans. And small business owners plan to keep on hiring new employees. Revenues are also stronger than they have been in years.
But that's not enough. The economy has been stuck at a GDP growth rate between 2 and 3 percent since the recovery began in 2010. And, according to some economists, we need to get to a rate between four and six percent before small business owners would see a noticeable, positive change.
The prime way to get to that kind of growth is by engaging consumer demand. And with wage growth and the labor participation rate both stuck at historic lows, we can expect the economy to keep growing at its current rate for some time.
Meanwhile, economic dangers can arise from keeping rates too low for too long. Among others, there's the risk of reckless lending, or too much spending.
"Interest rates can't stay this low forever, because there exists the real risk of the economy getting overheated," says Alex Nikolsko-Rzhevskyy, an associate professor of economics at Lehigh University. He adds that the federal funds rate needs to return closer to a rate of 4 percent.
Change on the Horizon
Meanwhile, there's still a strong chance that the Fed will raise the federal funds rate in December, during its final meeting of the year, Nikolsko-Rzhevskyy says. He cites, as his reasoning, all the groundwork the Fed has done this year to prepare markets and investors for a rate increase.
"It would be a sign that the Fed thinks the U.S. economy is doing well, and raising interest rates could increase consumer demand and confidence," adds Nikolsko-Rzhevskyy.