Suppose the Fed raises the target for the federal funds rate from 2% to 2.75%. This change of _ percentage points means that the Fed raised its target by approximately __ .
The correct answer and explanation is:
Correct Answer:
0.75 percentage points; 38%
Step-by-Step Explanation:
When the Federal Reserve (Fed) changes the target federal funds rate, it signals a shift in its monetary policy. Let’s break this question into two parts:
Part 1: The Change in Percentage Points
- Initial rate = 2%
- New rate = 2.75%
- Change = 2.75% – 2% = 0.75 percentage points
So, the Fed raised the rate by 0.75 percentage points.
Part 2: Approximate Percentage Increase
To calculate the percentage increase relative to the original rate, use this formula: Percentage Increase=(ChangeOriginal)×100\text{Percentage Increase} = \left( \frac{\text{Change}}{\text{Original}} \right) \times 100 =(0.752)×100=37.5%= \left( \frac{0.75}{2} \right) \times 100 = 37.5\%
Rounded to the nearest whole number, the Fed raised the rate by approximately 38%.
Economic Significance
A 0.75 percentage point hike is relatively large in monetary policy terms. Here’s why it matters:
- The federal funds rate influences interest rates across the economy—on loans, mortgages, savings, and credit cards.
- When the Fed raises this rate, borrowing becomes more expensive, and saving becomes more attractive.
- This can help slow down inflation, as it reduces consumer spending and business investment.
- However, aggressive increases can also risk slowing down economic growth or even causing a recession.
In this case, a 0.75 percentage point increase represents a 38% rise over the previous rate—an assertive move by the Fed to likely combat high inflation or an overheating economy.