I didn’t really understand the importance of the Federal Reserve and how its decisions affect everyday consumers until I was in my mid-20s.
This is Alex Gailey with NextAdvisor — and sure, many of us are taught about government systems and the role of the Fed in high school. But no one connected the dots for me on how the Fed’s decisions affect Americans’ bottom line and purchasing power.
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The Fed keeps an eye on several economic indicators, such as unemployment, consumer prices, and GDP. If anything is out of balance, the Fed steps in to try and get things back on track with monetary policy.
And that’s essentially what happened this year because of inflation. Consumer prices saw the largest increase in 40 years, so the Fed stepped in to try to tame inflation by hiking interest rates at a rapid pace. The hikes so far have not curbed skyrocketing prices as quickly as the Fed would like (inflation reached 8.3% in August), and the Fed announced another 75 basis point interest rate hike on Wednesday. Many experts say more rate hikes are on the way.
Higher interest rates make debt costlier and borrowing harder — for both consumers and businesses. That could have the effect of slowing down demand, and less demand means less money circulating in the economy, leading employers to reduce their expenses and cut jobs. In short: the Fed might slow things down too much, and that could have consequences. Most Americans worry the United States will fall into a recession later this year.
While you can’t control what the Fed does, you can make your own money moves in response.
An increase in the bank’s benchmark federal funds rate is painful for consumers — it means higher rates for credit cards, mortgages, auto loans, and any industry that relies on financing. With interest rates rising, you’ll want to try to borrow less, save more, and work on paying off any debt (especially credit card debt, which comes with double-digit interest rates) as fast as you can.
On the flip side, it’s a good time to save money — especially if you’re keeping it in the right place. Interest rates on savings and CD accounts are higher now because of the Fed’s rate hikes, which means greater earnings on your savings balances and a few more dollars back into your pocket.
Also, hold onto your long-term investments. Investors tend to panic when the Fed takes action, and that translates to more volatility in the markets. It’ll likely be a bumpy ride over the next few weeks, but experts say you should avoid selling and ride out the dips instead.
The Bottom Line
The Fed’s decision to raise interest rates this week affects your money, but it shouldn’t completely steer your long-term financial plan off course. Keep an eye on what the Fed’s doing and make small changes if needed to get closer to reaching your financial goals.