How Does the Federal Reserve's Interest Rate Affect Your Budget?
The Federal Reserve's recent interest rate hike has been on the minds of many Americans lately. How will this decision affect our budgets? This blog post will discuss how the Federal Reserve's interest rate hike can impact your wallet. We will also provide tips on adjusting your budget to make the most of this change.
Although you may not realize it, behind the scenes, the Federal Reserve significantly affects your day-to-day life, particularly on saving, spending, and borrowing. The Federal Reserve, also referred to as the Fed, is responsible for managing the USA's monetary policies (Fed, 2020). If you wonder how it does this, a significant part of managing the financial policies includes adjusting rates on the federal reserves. In a 2022 article on CNBC, Dickler reports that the Federal Reserve rate is the rate banks charge each other to borrow, even though it is not the rate consumers pay. While the Fed rate is different from the consumer interest rate, slight fluctuations in the Fed rates have ripple effects on the consumers' spending, borrowing, and spending; you need to understand how the Federal Reserve's interests affect your budgeting.
Increased Federal Reserve Rates
The Federal Reserve interest essentially affects you in two distinct ways. One of these is by increasing the Federal Reserve rates. The recent announcement that the Fed will increase the reserve rates is an event that has been on the mind of many US citizens. An article published in the Wall Street Journal on March 17, 2022, reports that the Fed agreed to increase the reserve rates setting the percentage at 2% higher than pre-COVID-19 rates (Timiraos, 2022).
The Fed increased the reserve rates in various cases. Shell (2022), for instance, reports the need to stimulate the economy and overcome the high inflation rate as one of the driving factors for this increased rate. The increased inflation has resulted from the economic slowdowns witnessed during the COVID-19 period, which caused disruptions in the global supply chains and the recent Russian invasion into Ukraine that has soared oil prices. In a press release, Jerome Powell said, "It's clearly time to raise interest rates," citing that the economy is stable and robust enough to withstand high borrowing rates. An increase in the Fed Reserves is not entirely alarming. It is what an increase in the Federal Reserve rates means for you.
When the Federal Reserve rates increase, the money you have saved earns more. Although you should generally not expect to make capital on a standard saving account, Carpenter (2022) notes that money held in funds such as money markets, certificates of deposits, and interest-bearing accounts will typically earn more. The Fed website reports that higher reserve rates usually attract more interest on deposits (Fed, 2020). If you want to make more from savings, now could be an excellent time to set aside some savings. However, the increased interest rate may be a temporal measure to stimulate the economy, notes Ngotran (2021). Husted et al., in their 2017 article on monetary policy challenges, echo these sentiments. Therefore, you should assess potential long-term strategies before investing in long-term saving projects.
An increased Fed rate is not all rosy. The higher interest makes it appealing for the banks to hold extra capital in their reserves. When banks lock their money in their vaults, cash flow in the economy reduces. There will be less money available for borrowing, and fewer funds will be circulating in the economy. It means that, as the interest rates increase, your buying strength will reduce.
At the same time, the prices of products are increasing due to inflation. It means that you have to stretch your money a little more. Timiraos, in a March article, also states, "it influences other consumer and business borrowing costs throughout the economy. The affected areas are mortgages rates, credit cards, saving accounts, loans on vehicles as well as corporate debt" (2022). Thus, another disadvantage is that you will have to pay more on borrowed loans.
Reduced Fed Interest Rates
A reduction in interest rate is another way Federal Reserve interest affects your budget. The Fed will reduce the rates to fuel the economy. In their article, O'Connell & Curry (2021) state that in the wake of the COVID-19 pandemic, the Fed reduced the reserve rates to zero in a bid to bring back the economy after nearly sinking to the brink. Although this move was successful, you may have noticed that your savings earned lower interest (Hall, 2017). When the Fed cuts the interest, it is no longer appealing for lenders to hold capital. Money becomes less expensive to borrow, and the circulation of cash increases, enhancing the buying capacity. This reduction means that lenders charge lower interest rates.
When money becomes more accessible, people typically have more money to spend. Cutting interest rates means that you may have more cash on your hands to spend or save. Some of the areas affected by the reduced interest rates include credit cards, student loans, personal and car loans, mortgages, and business loans. If you have any of these loans, repaying them at this time is a good idea as the interest rates are low, Herron reports in his 2020 article. At the same time, you can take advantage to refinance your high-interest debts. Generally, reduced Fed interest rates have an overall positive ripple effect on your spending and budget.
How Can You Adjust Your Budget for the Rising Interest?
By now, you have understood how Federal Reserve interest rates affect your budget. Unfortunately, these changes are above our control, and there is nothing we can do to change the situation. Your best bet is to prepare yourself for the anticipated rise or fall in the Federal Reserve rates. The recently announced increase in the Federal Reserve interest rates inarguably impacts your life, so you need to be ready to react to the change.
- One of the most effective ways to prepare is to equip yourself with adequate knowledge of how the Federal Reserve rates affect your spending. This information will enable you to maximize the benefits of borrowing and saving from each change. For instance, if you have a money market account, you can earn by putting in more money when the Fed increases the reserve rates. Similarly, you stand to gain more by increasing your borrowing when the Fed cuts interest.
- Secondly, you need to understand how these changes affect your purchasing power. High interests typically reduce the purchasing power. At this time, you may need to tighten your budget and eliminate unnecessary spending. In contrast, you are more likely to have more spending money when the Fed cuts the reserve interest.
- It is also essential to approach your financial institution to restructure your loan and mortgage. For instance, if the Fed has announced an increase in reserve interest rates, you should probably consider the prospects of locking your interest in a lower fixed mortgage before the rise.
- Lastly, there is no need to panic when these changes occur. More often than not, the Fed gives an early warning for the expected changes. Moreover, financial institutions do not necessarily implement these rises and cuts as soon as they are announced. It may take some time before you start to feel the ripple effect. The most important thing is to carry on and use your knowledge to maximize the benefits that come with each change.
- More importantly, keep in mind that these changes are part of everyday life. The Fed will always have to raise or reduce the reserve interest rates.
- Carpenter, J. (2022 March 17). What the Fed's interest-rate increase means for you. WSJ. https://www.wsj.com/articles/what-fed-interest-rate-hike-means-for-you-11647437999?mod=life_work_major_pos12
- Dickler, J. (2022 January 27). The Fed won't keep interest rates near zero forever — Here's what to do now. CNBC. https://www.cnbc.com/2021/01/27/how-the-federal-reserve-decision-affects-your-money.html
- FED. (2020 August 27). The Fed - How does the Federal Reserve affect inflation and employment? Board of Governors of the Federal Reserve System. https://www.federalreserve.gov/faqs/money_12856.htm
- Herron, J. (2019 July 30). Why does the Fed lower interest rates? US Today. https://www.usatoday.com/story/money/2019/07/30/federal-reserve-why-does-fed-lower-interest-rates/1861483001/
- Hall, R. (2017). Low interest rates: Causes and consequences. International Journal of Central Banking, 13(3), 103-117.
- Husted, L., John, R. & Sun, B. (2017). Monetary policy uncertainty. International Finance Discussion Papers, 1215. https://doi.org/10.17016/IFDP.2017.1215
- Ngotran, D. (2021). Interest on reserves, helicopter money and new monetary policy. PLoS ONE 16(7), e0253956. https://doi.org/10.1371/journal.pone.0253956
- O'Connell, O. & Curry, B. (2021 June 23). What happens when the fed cuts interest rates? Forbes. https://www.forbes.com/advisor/investing/fed-cuts-interest-rates/
- Shell, A. (2022 March 16). How Fed Rate hikes impact your finances. AARP. https://www.aarp.org/money/investing/info-2021/rising-interest-rates-impact.html
- Timiraos, N. (2022 March 17). Fed raises interest rates for first time since 2018. WSJ. https://www.wsj.com/articles/fed-raises-interest-rates-for-first-time-since-2018-11647453603?mod=trending_now_news_5