Interest Rates Cause and Effect

 Interest Rates Cause and Effect

Written by: Tejas Babel 

Due to the recent inflation, the Fed has increased the interest rate, and has announced that it will continue to do so until the inflation problem is solved. What does this mean for the average American? How much does the rising interest rates affect people’s lives? And what does rising interest rates mean for the Economy? The Fed increases its interest rates by increasing the federal funds rate. If the Fed increases its federal funds rate it’s more expensive for banks to get loans; hence, banks increase their interest rates on the average person. 

The federal funds rate also directs the greater economy, or changes its course.  This transition is often in multiple stages; for example, in 2020 Fed decreased its interest rate to 0%, and within a week the effect could be seen on the stock market. A month later the larger gap between GDP and stock market was created. It took GDP another 6 months to bounce back, and it took even longer for businesses to get back into profits. Hence, some sectors of economy are affected immediately while others take longer to respond. Common Americans are usually the last to benefit, but first to be hurt from these.  

In 2020 the interest rates were decreased, but recently the Fed has been increasing them to slow down the economy and reduce inflation to 2%. according to investopedia, the markets will react inversely from 2020. To avoid this sudden change in the direction of the economy, the Fed is gradually increasing interest rates at 0.25% intervals (quantity easing). According to CNBC, The Fed is gradually increasing interest rates so they can spread out the effect of the economy slowing down, and get a gauge of how effective these monetary policies are. It’s possible for there to be another recession because of this change in interest rates, but Fox news said “ The changes are too subtle for the employers to do a 180 degree turn from hiring to laying off people.” Hence, it would be reasonable to accept the economy would slow down to a point where there would be jobs for everyone but fewer openings, and the prices will stabilize. 

The state of the US economy overall is in an interesting position because the overall demand for goods has increased and the price level for supplies has also increased. Normally an increase in price level of supply would result in stagflation, but the high demand for goods counter it, but also led to more inflation. With the increase of interest rates the Fed is trying to reduce demand, and hoping that supply shortages will end. Furthermore, the ban of Russian oil has led to another supply crisis and has halted the rising of interest rates. 

Contrary to March 2020 the economy will see decline but it will not be as sharp, and the economy will plateau for the next couple of years. According to Forbes, the upcoming years are looking prosperous for the US economy in regards to increase in real GDP. While GDP will see a 4% increase. The job market is also predicted to sustain its current level of wage. Although the jobs aren’t at risk, Americans' financial state is at risk, many people bought houses at the low interest rates after covid, many of those homeowners will struggle to pay mortgage and home loans at the higher interest rate. 

Interest rate

Inflation 

Historical interest rates have been around 5% -6% but since 2008 the interest rate has been close to 0%. They were rising until covid hit, hence the Fed will likely restore the interest rate to pre-covid rates and see how the economy reacts before taking further measures. So for the common person it means that the interest on their credit cards and home will increase to pre-covid levels. 

All in all, rising interest rates will not lead to a recession, but slow the inflation and negatively affect wages for low income, unskilled workers and job availability will decrease. The Fed also predicts that many private big infrastructure investments will be delayed. Although some people argue that the 2020 response will lead to excess inflation; hence, the 2022 counter response will lead to some recession. But according to investopedia, in march of 2020 the Fed had to take immediate radical action to get the economy out of a recession, but now the Fed has more time and this shift in monetary policy will be smooth and the average American will be affected to a minimum. Although the Fed has to be very careful and focus on the fridual supply side of the economy because the economy can very quickly move towards stagflation.