In the United States of America, there are quite a number of factors that affect the growth of the economy. Two of them are inflation and interest rates. But how are inflation and interest rates managed??
The Federal Open Market Committee is a committee that is directly in charge of setting rules that alter the federal funds rate of the USA. This is the rate at which banks lend to one another overnight. The more it costs banks to borrow from each other, the more they will charge you and I for loans.
When this rate is very low, banks have a lower cost to borrow and the flow of money can increase substantially. This is usually the leading cause of inflation.
So to put this in check, the Federal Open Market Committee (FOMO) tries to balance economic growth with inflation.
But you may ask, does this have a negative effect? Who loses from this? Who gains from this? How does this help the economy? In this article, you’ll find out all you need to know about rising interest rates.
Keep reading.
Why Raise Rates?
There are few reasons why the Federal Open Market Committee may decide to cause a rise in interest rates. A few of them are:
To Curb Inflation
Ideally, a higher interest rate results in a reduction in demand for money. As stated earlier, banks loan money to lenders who in turn give out to borrowers. These borrowers may invest in businesses or use these loans to acquire a private property.
However, with an increase in the interest rate , people are less likely to borrow from banks to make investments or purchase anything new. This is because a higher interest rate leads to a higher monthly payment for the borrower.
Now, how does this reduce inflation?
A decrease in demand for products, services or an investment of any kind causes more people to save up their money and reduces the total money supply. Hopefully lowering inflation.
As interest rates climb, your savings rate at the bank should go up. If the rate gets high enough, more people will leave money at the bank.
This reduces the flow of money in circulation in the economy which in turn decreases inflation and keeps the economy in check. Also the demand for goods and services will go down, causing inflation to fall.
Business Pressures
As interest rates rise, consumer and business psychology is affected. Businesses that regularly borrow money to fund operations will have higher costs that they will most likely pass on to consumers. Consumers will have to pay higher prices or choose not to buy those goods.
If consumers buy less, business profits will go down…
Who Gains From Rising Interest Rates?
Practically all savers gain from rising interest rates. By increasing interest rates people have the ability to earn more money in their savings accounts. Also, anyone that has locked in a long term low interest rate on a mortgage or other type of loan will “technically” benefit from a rising rate as well.
Banks, insurance businesses, brokerage firms, and money managers, also gain from rising interest rates since their profit margins expand as rates rise. I know this might sound strange, but rising interest rates typically indicate a growing economy. When interest rates are too low for too long, borrowing can get out of hand…
Who Loses From Rising Interest Rates?
While savers and brokerage firms are enjoying this switch in economic events , borrowers feel the heat of the decision taken by the government.
New borrowers are worse off when there is a rise in interest rates because now it costs them more to finance a house, a car or even make investments.
The Bottom Line
Rising interest rates has its good sides and bad sides, however one of the things you can gain is higher interest in your savings accounts and if you locked in any long term loan (mortgage) over the last 3 years you have set yourself up very nicely.
At the Art of financial planning, we would guide you to make better decisions on how to save and take advantage of the rise to the fullest of your abilities. Contact us now.
