Interest rates are going up after a very long period of record near-zero lows. While your parents probably remember when interest rates were sky-high during the Reagan era, the rest of us young ‘ens don’t really have any recollection of when interest rates were closer to normal.
In fact, since June of 2006, we’ve only raised interest rates once. One year ago marked the first rate hike in ten long years, and now financial analysts are expecting several more to come in 2017. Here’s what you need to know about rising interest rates and how they affect your lifestyle.
Why are interest rates so low right now?
The Great Recession was a god awful, once-in-a-lifetime (or three-in-a-lifetime if you ask your grandparents) event that mangled the economy and threatened to completely unravel our entire way of life. Given that interest rates are the Federal Reserve’s first line of defense to grow the economy, they took the unprecedented step of lowering interest rates to zero (actually between 0 and .25%) to stimulate the economy.
Federal Reserve’s influence on interest rates
The Fed sets the federal funds rate, which is the amount banks charge one another for borrowing money. That rate influences all other interest rates across the entire economy.
The danger in not raising interest rates is inflation, or rising prices. Right now, inflation expectations have crept up, signaling that it’s indeed time to raise the overnight rate, and increase the cost of borrowing in the United States.
So what happens now?
Essentially, raising interest rates is like putting on the brakes in the world of monetary policy. Inevitably, the economy will slow down. Overall, this interest rate hike is a strong signal that the Federal Reserve is taking the economy off of life support and ready to put the worst behind us.
The overnight rate is going up a quarter of a percent, which will raise cost of borrowing on things like mortgages, credit cards and other loans. Everyone is watching closely because our economy has gotten used to near-zero interest rates.
Negative Effects
The U.S. Dollar will likely increase in value, further hurting American manufacturing, which has already lost ground because of a strengthening dollar in the past few years.
There are also fears that the real estate market will cool off suddenly after years of boom. Home prices have rebounded to near-pre-crisis levels because of rock-bottom interest rates. If they rise quickly, the cost of servicing a mortgage loan will surge, and could cause housing prices to tumble, as people are squeezed by larger monthly payments. You might recall that the last time the economy went sour it was caused by a crash in housing prices, and this has some analysts worried.
Takeaway
We’ve waited an awful long time to raise interest rates, and most analysts expected the Fed to hike interest rates faster. There has been a great deal of criticism that we’re risking higher than normal inflation down the road if we don’t begin to reign in Recession-era monetary stimulus.
The reality is that monetary policy is extremely complex, and it’s going to take years to figure out if the Fed made all of the right moves. In the meantime, brace yourself for higher borrowing costs.
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