News about global economic instability caused, in part, by a slowing of China's $10 trillion economy has created uncertainty about whether the Federal Reserve will announce today, Sept. 17, the first key interest rate increase since 2006. A live press conference at 2:30 p.m. Eastern will follow today's announcement. Guillermo Covarrubias, senior lecturer in the University of North Texas Department of Economics answers central questions in a Q-and-A.

Contact Covarrubias at 940-565-3186 (office) or Guillermo.Covarrubias@unt.edu.  He is available for interviews in English and Spanish.

What is the federal funds rate? How does it impact consumers and businesses?

Covarrubias: The federal funds rate is the interest rate charged on short-term, interbank loans. The federal funds market exists to match banks with a shortage of reserves with those that have excess reserves and is helpful to manage liquidity for banking institutions. 

The cost to banks for reserves will change when the federal funds rate changes, causing banks to also change the interest rates they charge for consumer and business loans. The changing interest rates affect the cost to borrow monies and have an impact on the cost of financing consumption and business projects, thereby changing the incentives of consumers and businesses to finance expenditures of durable and capital goods. 

Is a Federal Reserve increase still possible this year given global instability?

Covarrubias: These events have increased the uncertainty in the forecast for the gross domestic product, while at the same time making it less likely for inflation to accelerate above the two percent target. Given the change in the risk profile, it is a possibility that the Fed may opt to continue to be cautious and decide to delay the timing of their first rate hike. However, the option to raise rates, albeit less likely, remains on the table, given strong U.S, gross domestic product growth reported in the second quarter.

What does the Fed take into consideration when setting the interest rate?

Covarrubias: There is an extensive amount of data sets that the Fed considers when determining their stance on monetary policy. Three of the main data sets are the price of goods as measured by the core consumer price index, the unemployment rate through observations of the state labor market and Gross Domestic Product observations. The Fed keeps its options open and in their language, and again, they are data driven. That is essentially what is happening. They may wait to get data readings to better understand where the economy is headed before they take action.

Nine years have passed since the last interest rate rise. Was that necessary?

Covarrubias: The measures taken to respond to the financial crisis in 2008 were extraordinary. The economy has been distressed as a result from the troubles of financial institutions.  Research shows the Fed has taken periods like this one and erred on the side of caution regarding risks that may prevent the Fed from achieving their employment targets.

At the same time, the Fed is monitoring to try to prevent inflationary pressures from building up and to prevent expectations of inflation from becoming unanchored. They try to balance both goals, but in the most recent period, the fed considered a higher risk existed to trying to achieve their employment targets than their inflation targets. The higher uncertainty lead them to a stance in monetary policy with a higher weight on the uncertainty existing in labor markets in order to prevent the recovery from being derailed. 

What would an increase mean for the economy?

Covarrubias: Increasing interest rates increases the cost of borrowing money and discourages investment in capital equipment, housing and durable goods. Policymakers do not intend to reverse positive economic gains, only normalize policy, and they will work to minimize the effect.

The Fed has signaled that they would increase interest rates gradually, and in small steps, so as to not have too large of an impact on goods and labor markets. The market as a whole has probably factored this in; therefore, it will lessen the impact to the financial systems. This gives companies and individual consumers time to prepare. The Fed doesn't want to surprise anyone.