What does the Federal Reserve have to do with the way you manage your own money?
The nation’s central bank can impact how much interest you pay on your credit card debt, mortgage or car loan. It can also affect how much interest you earn on your savings.
The Federal Reserve announced this week that it’s increased its interest rate target by one-quarter percentage point, to a range of 0.75%-1%.
It’s the third Fed rate increase since December 2015 as we creep back toward “normal” pre-recession rates of 2-5%.
A boost in employment and price stability contributed to the Federal Reserve’s decision to raise the rate.
Last month, the unemployment rate settled at 4.7% — it’s been hovering at 4.6-4.9% for the past six months.
Just in Case You’re Curious What the Fed Rate Really Is
So what is the Fed rate? It’s the interest rate that banks use to lend money to one another, usually overnight. These amounts are held at the Federal Reserve to uphold the requirement that banks keep a certain amount of cash on hand.
Banks move money around to one another all the time at mutually agreed-upon rates within the Federal Reserve’s target range.
The higher the interest rate, the more expensive it is to borrow money. A slightly higher interest rate slightly reduces the amount of money floating around because it’s more expensive to borrow it in the first place.
What the Fed Rate Means for You
Right now, as you’re reading this? Not much.
Sure, the stock market jumped right after the Federal Reserve’s announcement, but your debts and savings won’t show an immediate change.
The Fed’s interest rate is designed to “stimulate economic growth by encouraging borrowing and risk-taking,” Binyamin Appelbaum of the New York Times explained in December.
In tough times — think 2008 — the Fed has lowered rates to encourage an active economy with plenty of spending despite consumer anxiety. Meanwhile, in better times, the Fed increases rates.
“When rates climb, borrowing gets more expensive for businesses and consumers so they may hold back somewhat rather than spending as aggressively as they otherwise might,” Gail MarksJarvis wrote in the Chicago Tribune. “The idea is to keep the economy from overheating.”
The Fed typically makes small increases to the rate to prevent the financial turmoil that could occur from raising the rate too much at once.
“The rate hike will increase the upward pressure on interest rates that consumers pay, but the immediate effect is likely to be modest,” Appelbaum reported on yesterday’s increase. “People with credit card debt are likely to see an immediate increase of about a quarter percentage point in their interest rates.”
Appelbaum also explained that banks usually raise interest rates on loans faster than they raise rates on deposits; so if you’re saving through a certificate of deposit, for example, you probably won’t see immediate interest added to your balance.
The smart move to make for your money? Pay down debts now before you have to account for that anticipated extra one-quarter percentage point in your monthly payments. Then, start pumping your post-debt money into high-yield certificates of deposit. Or just save it anywhere — in a bank, in a tin can, anywhere. Just start saving.
A Small Increase Now is Better Than a Larger Increase Later
Janet Yellen, chairwoman of the Federal Reserve System, noted in her press conference March 15 that core inflation, which includes prices for energy and food — stuff the average person has no control over, but definitely notices when the price takes a turn in either direction — has stabilized in recent months.
Yellen said the Federal Reserve expects this core inflation to increase and overall inflation to stabilize over the next few years, signifying overall economic improvement.
Further, Yellen explained that making a small increase in interest rates now could prevent the need to raise rates more quickly in the future if the nation’s monetary policy needs considerable adjustments.
A sharp, sudden increase in the Fed rate could put us at risk of another recession; making small increases now and over the next few years allows time for economic acclimation.
We’re likely to see several more small increases to the federal interest rate over the next few years.
Your Turn: How do you think the increase in the Fed rate will affect you?
Lisa Rowan is a writer and producer at The Penny Hoarder.