Calm Acceptance as Fed Enacts Its First Interest Increase in Seven Years

The Fed’s chief, Janet Yellen, taking questions Wednesday after a rate increase was announced.

WASHINGTON — The Federal Reserve’s much-anticipated “liftoff,” its first interest rate increase since the financial crisis, unfolded as quietly and smoothly as Fed officials could possibly have wished.

For the Fed, however, the hard work now lies ahead.

The Fed persuaded participants in the financial markets that a quarter-point increase in its benchmark interest rate didn’t matter much. But the big questions about the American economy haven’t changed.

It’s not clear whether steady-but-lackluster growth is now as good as it gets, or whether the economy is just starting to heat up. It’s not clear why inflation is so sluggish, or how many people without jobs would like to return to work.

In short, it’s not clear how quickly the Fed should raise rates.

“Nothing is really resolved about the normalization process except that we’ve moved through this first tiny step,” said Tim Duy, an economist at the University of Oregon who follows the central bank closely.

The Fed said on Wednesday that it would raise its benchmark interest rate to a range of 0.25 to 0.5 percent, ending a seven-year period of near-zero interest rates. By keeping rates low, the Fed has sought to encourage borrowing and risk-taking by businesses and consumers. It will reduce those incentives as it pushes up rates.

The Fed is raising short-term rates in a new way, by paying banks and other financial firms not to offer loans at rates below the bottom of its benchmark range.

To set the new base line, the Fed said it would borrow up to $2 trillion at a rate of 0.25 percent. On Thursday, however, firms offered only $105 billion to the Fed — less than the $114 billion average daily sum offered to the Fed during testing over the last two years.

Janet L. Yellen, the Fed’s chairwoman, emphasized that the central bank planned to move gradually, a term she has previously suggested means that the Fed will raise rates by about one percentage point per year. But there is already considerable divergence among Fed officials. Seven of the 17 members of the policy-making committee said the Fed should move more slowly, raising rates as little as 0.5 points next year.

Jon Faust, an economics professor at Johns Hopkins University and former adviser to Ms. Yellen, said Fed officials were basically trying to discern which of two possible versions of the economic reality was correct.

In the first version, low interest rates have helped the economy build up some significant momentum, and the Fed needs to raise rates more rapidly to keep a lid on inflation and financial excess.

Alternatively, low rates are necessary to preserve the modest pace of economic growth, and increasing them too abruptly could push the economy into recession.

“I think one of the trickiest and most important parts will be trying to figure out what’s going on with inflation,” Mr. Faust said.

Prices climbed slowly in recent years, suggesting that the economy remained weak. The Fed’s preferred measure of inflation — an index of personal consumption that excludes volatile food and oil prices — rose just 1.3 percent in the 12 months ending in October.

But Ms. Yellen and other officials have argued that temporary pressures like the fall of oil prices and the strength of the dollar are suppressing inflation, and that the strength of the labor market is a more important indicator.

The Fed said in its policy statement on Wednesday that it would “carefully monitor actual and expected progress toward its inflation goal.” Analysts described that as a higher bar than the Fed had previously established, indicating that it wants to see evidence that inflation is meeting its expectations before it presses too far ahead in raising rates.

Andrew T. Levin, a professor of economics at Dartmouth, said that change was important because the Fed’s forecasts had been “persistently mistaken” in recent years. “It will be helpful for policy makers to explain what sorts of inflation readings over coming months would make them comfortable,” said Mr. Levin, who has argued that the Fed should be careful not to raise rates too quickly.

Policy makers would be grateful for a clear-cut answer, but they probably won’t get it. Their choices would become more difficult if inflation remained sluggish even as other economic indicators continued to gain strength. A deepening divergence between the Fed’s models and reality would make it harder for Ms. Yellen to maintain unanimity about the central bank’s path.

The Fed has other reasons to press ahead with raising rates. One longstanding concern is that low rates will distort investment decisions, encouraging excessive speculation and even asset bubbles.

Regulators have pointed to a number of worrisome signs in recent weeks. A federal agency said on Tuesday that credit risks were “elevated and rising” for American corporations and many foreign borrowers, even as investors are demanding significantly higher interest rates on junk bonds and foreign debt. The report, by the Office of Financial Research, however, said overall risks to stability remained “moderate.”

Banks, too, are taking larger risks, according to a semiannual report published on Wednesday by the Office of the Comptroller of the Currency. The report said banks struggling to hit profit targets were loosening underwriting standards, particularly in high-growth areas like auto and construction lending.

“In the area of credit risk, the warning lights are flashing yellow,” Thomas J. Curry, the comptroller, said in a speech on Wednesday. “We can’t afford to wait until the warning lights turn red.”

Ms. Yellen and other officials have emphasized that they would prefer to address such risks through tighter regulation. But they won’t mind the incremental benefits of raising the bar for new lending. Jeremy Stein, a former Fed governor who has returned to teaching at Harvard, has observed that higher rates have the virtue of addressing even unknown problems.

Raising rates “gets in all the cracks,” Mr. Stein said in a 2013 speech. “Changes in rates may reach into corners of the market that supervision and regulation cannot.”

Higher rates also reduce the incentives for risk-taking by banks and other lenders by fattening their profit margins. Banks were quick to take advantage of the Fed’s announcement on Wednesday to raise the rates they charge on many loans but not the rates that they pay to depositors.

William C. Dudley, president of the Federal Reserve Bank of New York, has emphasized that the Fed needs to make sure that changes in its benchmark rate are indeed influencing broader financial conditions.

But Ms. Yellen, asked about that on Wednesday, suggested she did not see great reason for concern. “We have a far more resilient financial system now,” she said, “than we had prior to the financial crisis.”

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