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Impact of the Federal Reserve Raising Interest Rates

The US economy has been experiencing inflation for quite some time now. This negatively affects the general public, as the prices of goods and services increase (demand outpaces supply). Less people can afford to buy goods and services, which means not only are they unable to obtain necessities, but businesses are negatively impacted as well by the reduction in purchasing power. To combat this, the Federal Reserve-- colloquially known as the Fed-- can raise the target interest rate, the rate at which banks borrow and lend money (federal funds rate). In fact, the Fed has raised the target interest rate on 15 June 2022 by 0.75%, the largest single raise since 1994. This impacts the public in several ways.



Borrowing money will be more difficult because of the hike in interest rates. The Fed tries to control inflation by controlling the federal funds rate. By increasing the federal funds rate, the amount of money able to be used for buying is reduced. Interest rates for loans-- car, student, businesses etc. -- mortgages, home equity lines of credit and credit cards increase as a result. Interest is the amount of money lenders earn as compensation for taking the risk to lend money to someone, and the interest rate is the percentage of the loan charged as interest. Higher interest rates mean that people are paying more for loans, which leaves them with less money to spend on other purchases, reducing demand and inflation. The less demand there is for a product or service, the lower the price drops, alleviating inflation. For example, the rising interest rate for mortgages means that less people can afford to buy houses, especially with the recent skyrocketing of house prices. Because fewer people are buying houses as a result of the higher cost, the demand for houses decreases, and the price of houses drop to encourage people to buy more houses.

Saving rates will increase with the interest rate raise, though, positively impacting any money saved. Low interest rates negatively affect saved money because they earn very little. This was seen with the pandemic, as savings accounts, certificates of deposit, and money market accounts earned almost nothing because of inflation. High interest rates positively affect saved money because the interest earned from the savings increases.

Markets will also experience adjustments with the raise in interest rates. Low interest rates forced investors to invest in riskier investments, such as stocks, because government bonds were worth less. Higher interest rates means that the stock market has to compete with government bonds. This combined with the most recent bear market (a drop in investment prices by 20% or more from the most recent high) have brought renewed fears of a recession.

Increased interest rates can potentially exacerbate the difficulties experienced by the general public through sparking a recession. By making borrowing costs too high, too fast, the amount of spending severely reduces, causing a severe drop in demand for goods and services. While this ends inflation, it brings on recession. When the economy is so slow a recession occurs, unemployment increases. Unemployment is currently low and the job market sees considerable growth, so the Fed may be banking on this for the foreseeable future.



Sources

https://www.investopedia.com/articles/insights/122016/9-common-effects-inflation.asp

https://www.cnn.com/2022/05/04/economy/fed-may-interest-rates/index.html

https://www.investopedia.com/articles/stocks/09/how-interest-rates-affect-markets.asp


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