The Effects of

Federal Funds Rates Increase on

U.S. Economy and What to Expect:
A Recommendation Memo:

Prepared for: Michael Kim, PhD.

Associate Director and Professor
Washington State University
Prepared by: David Park, Undergraduate Student
March 6, 2016

Washington State University

PO Box 646210
Pullman, WA 99164

Memo to Dr. Kim

Date:
To:
From:
Subject:

Februrary 28, 2016

Page 2

March 6, 2016
Michael Kim, PhD
Associate Director and Professor
Washington State University
David S. Park, Undergraduate Student
Washington State University
Recommendation Memo
Purpose

The purpose of this recommendation memo is to inform people about the increase in the
federal fund rates propose economic/financial, and give them financial recommendations
to people in regards to this increase.
Summary
On December 2015, Janet L. Yellen, chairwoman of the Federal Reserve Bank,
announced that the Federal Reserve Bank decided to increase the federal fund rate1, or
also known as short-term interest rates, to a range between 0.25 percent and 0.5 percent.
She also announced that fed officials are intended to keep increase short-term interest
rates to substantially increase the economic growth (Press Release, 2015).
People can easily find about this issue on internet and news media. There are many
different opinions regarding this issue. Some believe this is going to help our economy
grow. However, some others believe this will hurt economic growth, because while
investors and savers enjoy this, borrowers will have difficult time loaning money and
they will have to pay more money for interests. (Brecht, 2015)
This recommendation memo is written to inform and educate people, and give them some
recommendations regarding this issue. To conduct this study, I have reviewed two
scholarly articles. One article used credit default swap spreads2 (CDS spreads) to evaluate
the issue by Diaz et al. (2015), and the other article used the U.S. stock market for an
evaluation of this issue by Gurrib, Ikhlass (2015). Since they used different data, those
two articles have different conclusions and expectations regarding to increase in the
federal fund rates.
The effects regarding to this issue is much complicated than what many news media is
telling. Currently, the Federal Reserve Bank is still in the process of making
adjustment/decision about this issue. My recommendation to the people is that they
should not worry about the outcome of the increased federal funds rate, because if people
lose their confidence in banks and government, then the banking system and our
economy will suffer and may experience recessions or even depressions.
1
2

Interest rate banks charge each other on loans used to meet reserve requirement.
Premium paid by protection buyer to the seller

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Introduction
On December 2015, Janet L. Yellen, chairwoman of the Federal Reserve Bank,
announced that the Federal Reserve Bank decided to increase short-term interest rates to
a range between 0.25 percent and 0.5 percent. She also announced that fed officials are
intended to keep increase short-term interest rates to substantially increase the economic
growth (Press Release, 2015).
This is a very significant and important event, and there are many different opinions
about this issue. Some believe this will promote economic growth, because investors and
savers are going to enjoy greater returns on their investments. However, some others
believe this will hurt economic growth, because while investors and savers enjoy this,
borrowers will have difficult time loaning money and they will have to pay more money
for interests. (Brecht, 2015)
People who have studied economics or finance may have some better knowledge and
expectations about this with more details, but people who did not have studied or do not
have good knowledge in this subject would not have good expectations and they would
not know who to listen or what to believe.
There are many news articles about this issue, but they do not really discuss in depth.
They lack of scholarly information as well. This monetary policy is based on rational
behavior of people, but not all people behave rationally, making the outcome
unpredictable. Therefore, no one is know for sure exactly how this is going to affect the
market and economy. There needs to be research on this issue.
Research Methods
I concluded that conducing secondary research is going to be efficient and beneficiary to
this recommendation memo. To conduct the secondary research, I broke the project into
three tasks:
1. Find Relevant Scholarly Writings
2. Review relevant economic theories, hypotheses, and scholarly writings
3. Analyze the information
In the following discussion of how I performed each task, I explain the reasoning that
guided my research.
Task.1 Find relevant scholarly writings
For any secondary research, literature review is the most important task of research. So, I
am going to use trustworthy database such as EBSCOhost, and Google Scholar. I will use
the following terms to find relevant scholarly articles: federal funds rate, monetary
policy, economy, effects, short-term interest rate, and Federal Reserve Bank. I will try to

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find two or more scholarly writings for this research. Once Im done finding those
articles, then I will briefly write summaries of those articles.
Task. 2 Literature review
After I am done finding the relevant scholarly articles, I am going to summarize each of
articles, and discuss their conclusions. Evaluation/Analyzation will be done in the
following task.
Task. 3 Analyze the information
In this task, I will analyze the information of different articles together, explain why they
have either same conclusions or different conclusions, and discuss whether the
information the articles presented are correct or not. However, I am not going to use any
empirical model, economic model, or statistical result to analyze the information since it
takes too much time and it requires advanced level of economics.
Results
Task.1 Find relevant scholarly writings
I found two articles from EBSCOhost and Google Scholar. One research article is called
The information content of an increase in federal funds rate from a zero lower bound
environment. This article is published in Social Science Research Network and written
by Violeta Diaz, Harikumar Sankaran, and Subramanian R. Iyer in 2015.
The other one is called The Impact of the Federal Funds Rate on an Investors Return."
It is written by Ikhlaas Gurrib in 2015 and is published on Journal of Economic &
Financial Studies. Dr. Gurrib holds a PhD in Finance and a Bachelor of Commerce
(Economics and Finance) from Curtin University.
Task. 2 Literature review
Studies done by Diaz et al. (2015) examined the impacts of an increase in federal funds
rate on corporate and municipal bond credit default swap, or known as CDS, spreads.
They have concluded that the increase in the federal funds rate cause a decrease of 59%
in CDS spreads. When CDS spreads decrease, it suggests decrease in risk, which is a
good sign for the economy. However, they wrote that this reaction is observed only for
investment grade bonds. In the conclusion, they interpreted the federal funds rate increase
as a weak but positive signal of economy recovery.
Another research study done by Gurrib, Ikhlass (2015) analyzed the effects of changes in
the federal funds rate on the domestic U.S. market returns studied through S&P 500 and
the international UAE Dubai Financial Market (DFM). His findings suggest that the
DFM index is highly sensitive to the change in the federal funds rate compared to S&P
500 index. Positive changes in the federal funds rate tend to affect the DFM returns more

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negatively than S&P 500 returns, meaning any future positive changes in federal funds
rate would affect the financial markets negatively, by pulling prices down globally.
In next section, I am going to explain why there is a contradiction between those two
research studies.
Task. 3 Analyze the information
Both of the studies are done in 2015, which is very recent and they are all from credible
sources. Although both of studies are examining the effects of federal funds rate, there
are some conflicts between two research studies that I have found in the literature review
section. The first one suggests that increase in the federal funds rate is a positive signal of
economy recovery. However, the second one suggests that the increase in federal funds
rate would affect the market negatively, so there is a contradiction between these two
research studies.
The first article is focused on domestic market point of view and its authors used the CDS
spreads to analyze the impacts. However, the second one is focused on global market
point of view, and it uses the stock markets/returns to analyze the effects of federal funds
rate. I cannot say which of those two is a better approach/method, but I can say that both
ways are useful to understand the effects of change in federal funds rate.
Conclusions
After reviewing and analyzing the two different articles, I thought the effects of the
increase in the federal funds rate are actually more complicated than what the many of
news media is telling people. It is maybe easy to tell people about the effects in the
microeconomic level, but it is not so easy tell about the effects in the macroeconomic
level.
At this point, nobody knows what exactly is going to happen, so people should not be
afraid of this situation for not knowing what is going to happen. In recent news, on Feb.
10, 2016, Federal Reserve Chairwoman Janet Yellen said the Federal Reserve Bank is
considering negative interest rates, and committees are evaluating this decision at the
moment. However, the main goal of the Federal Reserve Bank is to stimulate the
economy and increase the economic growth rate.
Recommendation
My recommendation to the people is that they should not worry about the outcome of the
increased federal funds rate, because if people lose their confidence in banks and
government, then the banking system and our economy will suffer and may experience
many recessions.

Memo to Dr. Kim

Februrary 28, 2016

Page 6

References
Diaz, Violeta, Harikumar Sankaran, and Subramanian R. Iyer. "The Information Content
of an Increase in Federal Funds Rate from a Zero Lower Bound Environment." SSRN
Electronic Journal SSRN Journal. Web. 27 Feb. 2015.
Gurrib, Ikhlaas. "The Impact of the Federal Funds Rate on an Investors Return." Journal
of Economic & Financial Studies JEFS 3.01 (2015): 75. Web. 27 Feb. 2016.
Press Release. (2015, December 16). Board of Gorvernors of the Federal Reserve System
Retrieved February 15, 2016, from http://www.federalreserve.gov/newsevents/press/
monetary/20151216a.htm