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At 2pm EST (or 6am in AEST), the Federal Reserve announced that it decided to raise the interest rate by 0.25% from the target range 0-0.25% to 0.25-0.50%. Here is the full release:

Information received since the Federal Open Market Committee met in October suggests that economic activity has been expanding at a moderate pace. Household spending and business fixed investment have been increasing at solid rates in recent months, and the housing sector has improved further; however, net exports have been soft. A range of recent labor market indicators, including ongoing job gains and declining unemployment, shows further improvement and confirms that underutilization of labor resources has diminished appreciably since early this year. Inflation has continued to run below the Committee’s 2 percent longer-run objective, partly reflecting declines in energy prices and in prices of non-energy imports. Market-based measures of inflation compensation remain low; some survey-based measures of longer-term inflation expectations have edged down.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee currently expects that, with gradual adjustments in the stance of monetary policy, economic activity will continue to expand at a moderate pace and labor market indicators will continue to strengthen. Overall, taking into account domestic and international developments, the Committee sees the risks to the outlook for both economic activity and the labor market as balanced. Inflation is expected to rise to 2 percent over the medium term as the transitory effects of declines in energy and import prices dissipate and the labor market strengthens further. The Committee continues to monitor inflation developments closely.

The Committee judges that there has been considerable improvement in labor market conditions this year, and it is reasonably confident that inflation will rise, over the medium term, to its 2 percent objective. Given the economic outlook, and recognizing the time it takes for policy actions to affect future economic outcomes, the Committee decided to raise the target range for the federal funds rate to 1/4 to 1/2 percent. The stance of monetary policy remains accommodative after this increase, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.

The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the federal funds rate is well under way. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.

Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Charles L. Evans; Stanley Fischer; Jeffrey M. Lacker; Dennis P. Lockhart; Jerome H. Powell; Daniel K. Tarullo; and John C. Williams.

Thara – The world didn’t come to an end. However, the prospect of future monetary tightening may have unintended effects on countries that rely heavily on cheap US dollar.

In particular, Chinese economy may begin to suffer as a result. Since 2008, after the rest of world suffered from the Great Recession, China experienced massive influx of capital nominated in US dollar, seeking for better yields. That massive influx has now turned into massive outflow. For those who have experienced the 1997 Asian crisis, this should ring an alarm, as significant outflow generally predate economic crisis. China is no exception.

The problem is further exacerbated by the People’s Bank of China (PBOC) insistence on some form of currency control. So, it is caught between rock and hard place. On one hand, PBOC tries to stimulate the slowing economy by lowering interest rate. On the other, it uses US dollar in its balance sheet to buy back Yuan to strengthen the currency. This reduces circulation of M2 money  (money easily convertible into cash) in the economy. This has an effect of tightening the economy when the opposite is needed. The analogy is this: PBOC is trying to slam on a brake and an accelerator at the same time.

It is like the US hanging on to the gold standard during the Great Depression. Its economy suffered. It wasn’t until Franklin Roosevelt took the US off Gold Standard that the economy began to recover.

In case of China, it is likely that it will have to stop currency control or be forced to. Time will tell.

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