PennyWorks explains the five ways inflation affects interest rates set by the Federal Reserve.
5 effects of inflation on interest rates
5 effects of inflation on interest rates
Like the Federal Reserve raised interest rates by half a percentage point, many Americans are wondering how the move affects their wallets.
The increase puts the federal funds rate at nearly 1%, up from 0.33%, the highest level since March 2020. The Bureau of Labor Statistics (BLS) announced in May 2022 that consumer prices increased by 8.3% over the year ending in April 2022. Restaurant and eat-out prices increased by almost 7% compared to last year, while grocery prices have increased by 10%according to the US Department of Agriculture.
The Fed anticipates the federal funds rate will reach 1.9% at the end of 2022, and 2.8% by the end of 2023. That may not seem like much, but it can significantly affect consumer spending and borrowing. Fed Chairman Jerome Powell’s goal of raising interest rates largest single rate increase since 2000 is to fight inflation, but without triggering a recession. The slowdown in the housing market and the volatility of stock prices show that this task will prove difficult. the The rate of real estate loans over 30 years is already growing to 5% as house prices cool down in several metros.
To explain the different ways this will impact daily household budgets, PennyWorks has compiled a list of five ways inflation affects interest rates. Data sources include the Federal Reserve, Reuters and The New York Times.
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Higher interest rates
Driven in part by soaring housing, food and energy costs, the Department of Labor says the current rate of inflation in the United States is the highest recorded in 40 years. The Federal Reserve has historically raised the federal funds rate to curb high inflation. The federal funds rate hit 20% in 1980, as inflation soared following the energy shocks of the 1970s.
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Lower interest rates
In historical periods of low inflation, the Fed has lowered the federal funds rate. Following the collapse of internet companies in the early 2000s, the Fed lowered it to less than 1% for fear of potential deflation. “Taking note of Japan’s painful experience, policymakers feared that the United States could slide into deflation and as a result the FOMC’s target interest rate would hit its zero lower bound, limiting the possibility of further monetary easing,” the former said. Fed Chairman Ben Bernanke in a 2010 speech.
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Consumer loans
When the Fed changes the federal funds rate, that means consumer loan rates — mortgages, auto loans, credit cards, etc. – also increase. During times of inflation and high interest rates, this can impact demand for consumer products as well as the homes, cars, and other major purchases that people finance.
By making buying products on credit or borrowing at higher interest rates less attractive, high inflation can also slow demand and economic growth.
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Savings accounts
rapid inflation lowers the “real” interest rates earned on savings accounts. This ends up devaluing the money stored in the banks, which drives capital into the financial markets and real estate. Inflation has also pushed investors into more volatile or speculative assets, such as cryptocurrencies and non-fungible tokens.
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Impact delay
The Fed often lags inflation when setting interest rates. In an attempt to anticipate the evolution of inflation, the Fed could change the federal funds rate before inflation gets out of control. But thanks to pandemic-fueled government spending and increased food, fertilizer and feed costs of the Russian-Ukrainian war, the rise in prices will persist for months.
This story originally appeared on PennyWorks and was produced and distributed in partnership with Stacker Studio.
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