Fed Rates
(Continued)
The Fed will adjust the fed funds rate to effect changes in the American economy. To boost economic growth, the Fed will lower rates, which makes borrowing money cheaper for banking entities, who pass down this saving to their customers, encouraging consumers to borrow money (take out loans, charge purchases to their credit cards, etc.) and increase spending.
The Fed can also increase rates to slow borrowing and spending. They often do this in response to growing inflation in the economy, when people are spending so much that prices are skyrocketing and the economy is “overheating.”
Regardless of which direction the fed funds rates are changed, it takes about 12 to 18 months for the change to affect the greater economy.
How raising the rate affects you
The higher the fed funds rate, the less likely banking institutions are to borrow money to keep their reserves at the required levels (because they don’t want to pay the higher interest rate for borrowing that money). If a bank wants to avoid having to borrow extra Federal Reserve funds at the higher rate from another bank, they will lend less money out to consumers. The money they do lend out will be at a higher interest rate.
After a fed funds rate increase, banks will first raise interest rates for their business clients—known as the “prime rate”—usually within a few days of the Fed’s announcement. Because loans are now more expensive for them, corporations will be less likely to borrow and grow their business, which means employees are less likely to see bonuses and large pay raises.
Because adjustable-rate (also called variable-rate) loans like certain mortgages, home-equity lines of credit, some private student loans, and credit card rates are benchmarked against the prime rate, they are the next to be affected by the increased rate, typically within 60 days of the change. Homebuyers will now only be able to afford smaller loans, slowing the housing industry.
At the same time, the price of other goods like food and gasoline will stay low, and each paycheck should stretch further as inflation is slowed. Rising rates will also benefit those who have money in high-yield savings accounts.
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