We were going to do a Rundown feature on this, but figured a 10-Point Expert would be more helpful.
On Wednesday the Fed decided to raise interest rates. This is a big deal. Let us explain in out 10-Point Expert.
Point 1: It’s important to note, the interest rate we are talking about regarding the Federal Reserve (the Fed) aren’t the same type of interest rates that we generally think about for mortgages, student loans, and credit cards. When we say “the Fed has raised the interest rate”, we mean something called the federal funds rate.
Point 2: The federal funds rate is the interest rate in which depository institutions (banks, credit unions, savings/loans institutions) borrow money from each other. For many, the federal funds rate indicates the health of the economy. Because of this, if the Fed decides to push the rate up or down, it generally affects how we borrow money in the US.
Point 3: On Wednesday, the Fed decided to raise their federal funds rate from 0% to 0.25%. The Fed also indicated that it won’t raise interest rates too quickly, letting the economy have room to grow.
Point 4: The Fed’s decision to raise interest rates comes from recent reports – which include the monthly jobs report – that the current state of the economy is improving. While the interest rate raise of 0.25% itself isn’t that significant – it’s a relatively small bump that won’t affect the overall US economy – but mere fact that the Fed decided to raise the rate indicates to their confidence that the US economy is going “back to normal” (aka before the 2008 recession).
Point 5: The mere fact that the Fed is raising the federal fund rate means they are gaining confidence in the economy once again, which is definitely a good sign. With this action, the Fed believes people are starting to spend more, which means we are showing early signs we might be leaving the 2008 recession behind us!
Point 6: For the most part low interest rates are a good thing, but when you keep interest rates low for too long, you run into the risk of inflation (having too much money in circulation which devalues the currency). Considering the US economy is doing better, the Fed wanted to take precautions to combat potential inflation.
Point 7: Trying to control inflation is less of an economic science as it is more of an economic art. Theoretically speaking, the Fed increasing the interest rate to keep inflation low is a sound move.
Point 8: Some economists say the Fed may have acted too early. As a whole the interest rate is very low right now and if market forecasts are to be believed, it should be low for the next decade. Given the fact that inflation is so low, some experts didn’t see the harm in keeping interest rates low to see if the economy could grow even more than it has.
Point 9: On the flip-side, there’s also a case to raise interest rates as well. Before 2008, it had been decades since the interest rate was at zero. Keeping it this low for this long, was in many ways, flirting with the economic unknown. Also if you ignore volatile markets (like food and energy), inflation rate is at 2%, exactly were the Fed would like to be. So if you were to look at it that way, then right now would be the ideal conditions of raising the interest rate.
Point 10: The Fed’s decision to raise the interest rate might seem distant to the average person, but in reality it can have major impacts to everyday people moving forward. As we said earlier, just a 0.25% interest rate hike isn’t going to have an effect on the economy directly. You’re still going to have the same interest rates in buying a home or car in the near future. However the decision to start raising interest rates absolutely does matter to everyday people. Now to say how that will exactly affect people like us, that remains to be seen.
(Photo Credits: Google Images)