How the Fed Interest Rate effects our Economy

The Fed interest rate was increased recently to 2.5%. This rate hike is the fourth increase this year, with two more currently planned for 2019. Some theories think the recent interest rate hikes are the cause of the current stock market decline.

The Fed has said they are shooting for 3% interest rates in 2019. The hope is they will hold that rate for a while, until the next recession, where they can lower the interest rates to boost the economy (if needed).

I wanted to understand what the Fed interest rate effects, so I did research and gathered my notes.

History of Fed Interest Rates

From June 2004 through June 2006, the Fed raised interest rates from 1% to 5.25%. In September 2007, the Fed started lowering interest rates. The rate fell to 0% in December 2008, in response to the 2007-2008 financial crisis. The Fed began increasing interest rates again in December 2015, and we are living in the latest trend to get the interest rate at a safer level.

The Fed uses low-interest rates to boost the economy during recessions. When the interest rate is close to 0%, which it was from December 2008 through December 2015, there isn’t much the Fed can do to help the economy. A lower interest rate has the side effect in making investments in developing countries more attractive (like China and Mexico). It encourages companies to borrow more money for growth. A higher interest rate increases the value of the U.S. currency while bringing down the value of international currencies.

The hope is the economy will expand with lower interest rates. The reverse happens when interest rates increase.

Consumer Credit Interest Rates Increase

Consumer credit works off of the prime rate. When the prime rate increases, interest on credit cards, home loans, and other fixed/variable interest rates go up. In other words, it costs more for businesses and consumers to borrow money with a higher interest rate.

Saving Account Interest Rates Increase

The amount of interest earned on savings rate increases as the interest rate goes up. As of right now, you can get an American Express Savings Account with a 2.10% interest rate. This rate is enormous compared to what you could get before in the 0.01% – 0.11% range with traditional saving accounts. As the Fed interest rate continues to go up in 2019, the earnings will most likely increase.

With higher interest rates, borrowing becomes more expensive but saving cash in high-yield saving accounts earn more money. If you don’t have a high-yield savings account, this is a great time to set one up. The Discover Savings Account will also give you a $200 cash bonus with a $25,000 deposit. The 2% interest rate isn’t as good as the AMEX savings account (and others), but it still is a substantial rate. These saving accounts don’t have brick and mortar locations that you can walk into, but you can do everything you need online. Just like every other savings account, you can only make up to six withdrawals per month.

Once we get credit card debt free and start saving for an emergency fund, we will be opening one of these accounts for fast and easy access.

Here is a list of solid high yield saving accounts:

CD Interest Rates Increase

Across the board, CD (Certificate of Deposit) interest rates go up. These usually have a higher rate than a traditional saving account, with a set date when they mature. However, the cash is less accessible.

CD’s are a great option to store cash that you don’t need soon. Especially if you have a large nest egg and are near retirement. CD’s guarantee a fixed rate of return on your money and are less risky. The risk lies in the fact that you could get locked into lower interest rates if the interest rate for CD’s goes up. But you are pretty much guaranteed not to lose your investment.

Here are some CD options that are currently available:

U.S. National Debt

A higher Fed interest rate will cost the U.S. government more to borrow money. We currently have almost $22 trillion of national debt. Which means our government is continually spending more than it brings in. As the national debt increases, it will have an adverse ripple effect on our economy. And there is a chance this could cause a national financial crisis we cannot ignore. If the government learned how to manage a budget, we could avoid this problem.

We could be looking at lower wages and higher taxes to try to reduce the problem. But until we can figure out a way to not spend more than we make, the national debt will increase.

Mortgage Interest Rates and Home Sales

Mortgage interest rates will go up, leading to more people trying to close their loans faster. It also may prevent new homeowners from entering the market, in the hopes of getting a better interest rate. Currently, the best mortgage interest rate loan on a 30-year mortgage is 4.4%. In September 2017, it was at 3.78%. A year before that it was 3.4%. The current estimate is it will hit 5% by the end of 2019.

For some context, the mortgage interest rate was near 16.04% in 1981. But, we also have to consider home prices have gone up a lot since then. Still, the average mortgage interest rate since 1971 is about 8.16%.  The 3% – 4% interest rates we have seen in recent history is incredibly low! Those rates are not sustainable over long periods.

Consumer Spending

Since it will cost more to have consumer debt, along with higher saving account interest rates, people will think twice about spending money. This lower spending can have drastic effects on the economy and could spur a downturn. Business profitability could go down for a lot of businesses, which could drive down stocks. A big part of our economy depends on people spending money.

If you are spending more than you make, this will hurt you dramatically. Hopefully, it will be a wake-up call for people to realize that this is not sustainable, and destroys their financial future.

Summary

Rising interest rates benefit savers, but it costs more to borrow money. The cost of holding large credit card balances should be motivation to get rid of credit card debt. We should be looking at saving as much money as we can. CD’s are looking very attractive, and with it being unknown in how much farther the stock market will fall, and for how long, it is a great way to lock in a guaranteed interest rate.

We should also see the balance of our emergency fund increase, as savings accounts offer attractive interest rates (especially if you go with an online bank offering 2.10% interest).

It is good to keep an eye on what the Fed is doing, but we should focus on how we can secure our financial future. If we can make smart and educated decisions, we will be less concerned what the Fed and markets are doing.

Are you glad the Fed is increasing interest rates? Do you see this as being positive or negative?

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