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Understanding Federal Reserve Interest Rate Hikes: Impacts and Implications

By Nooreen B
Modified on February 7, 2024
Federal Reserve Interest Rate Hikes

The Federal Reserve is the central bank of the United States and works to regulate the monetary and financial system of the country. Recently the bank hiked interest rates as a part of its strategy to fight the current inflation rates. The Federal Reserve has the ability to steer interest rates. They can do this by either lowering or raising interest rates on the balances that are stored with them. And they can do so strategically to stabilize the United States economy and financial system. This past week the Feds raised interest rates again after several increases in the past year.

But what does that mean for Americans? What will be the impact and implication for consumers and businesses? This article summarizes what could happen next, along with some general information on the Federal Reserve and its role in interest rates. 

Overview of Federal Reserve Interest Rate Hikes

Recently the Federal Reserve announced that it will raise its benchmark interest rate to a range between 5% and 5.25%. This move was made to try and protect the United States economy from a recession, which usually comes right after high inflation rates. 

Definition of Interest Rate Hikes

Interest rate hikes are exactly what they sound like an increase in interest rates. Interest rates make borrowing more expensive for consumers and businesses. 

How the Federal Reserve Hikes Interest Rates

The Federal Reserve can hike interest rates by increasing the interest on any funds that are stored in their accounts—and not surprisingly, that impacts the rates of borrowing for the nation. 

History of Federal Reserve Interest Rate Hikes

Throughout the years, the Federal Reserve has hiked interest rates to help protect and regulate the U.S. economy. Here is a quick overview of significant past activity with interest rate increases: 

1981-1990 — The Great Inflation

In 1980 inflation had been the highest ever recorded at 14.6%—referred to as the Great Inflation. To combat this extremely concerning inflation rate, the Feds set a target interest rate of 14%. By doing so, they essentially created a recession which was necessary to combat this sky-high inflation rate. 

1991-2000 — After the Great Inflation

1991 through 2000 saw high inflation again. In response to concerns after this period of significant inflation, the Federal Reserve convened an emergency meeting on April 19, 1994, where rates were hiked. However, a few months later, borrowing costs were reduced at an impromptu gathering on October 15, 1998.

2004-2006 — Tech, 9/11, and 2008’ Recession

The early 2000s brought the most changes in interest rate spike and decline due to various factors such as influences from the technology sectors in the country, the 9/11 attacks, and the 2008 recession. Interest rates spiked 17 times between 2004-2006, mixed in with declines in interest rates as well. 

2011-2020 — Another Increase in Rates

From 2010 to 2015, Federal Reserve hikes were slow until 2017, when they went up three times, and in 2018, there were four additional hikes. By the end of these few years, the interest rates peaked at around 2.5%.

2022 to The Present — A Pre-Covid Economy 

After the pandemic, inflation has reached and is still currently at sky-high numbers. To combat this, the first interest rate spike was in March 2022; after that, there were 10 consecutive hikes, including the most current one.

The General Pattern With Interest Rates

Once you see the basic patterns of how the Feds tackle interest rates, you don’t have to be an expert to figure out potential trends and interest rate hikes or declines in the future. Essentially, if inflation rates are high, the Federal Reserve will increase interest rates to help combat that high inflation rate, which can add some padding to a potential recession. 

While in times of consumer economic hardship, such as the 2019 pandemic, they will cut down on interest rates to help consumers and businesses afford more and ultimately contribute to the slowed-down economy. 

Impact of Federal Reserve Interest Rate Hikes

There is definitely going to be an impact on consumers and businesses when there is an interest rate hike. For both companies and consumers, the price of borrowing funds will increase; here are some examples of loan types that will increase interest:

  • Mortgages — It will be more expensive to purchase/finance a home. 
  • Personal loan, Business loan, and Credit Card Options — Any type of personal or business borrowing/spending, such as credit cards and personal loans, will come with higher interest rates. 

And so, for borrowers and businesses, borrowing funds will be expensive. Due to higher rates, most consumers and companies will be more hesitant to spend money or borrow funds, slowing down the economy and bringing down inflation levels. 

Effects on Financial Markets

Hikes in interest rates will have a ripple effect on financial markets—including the stock market. Typically, these changes take about 12 months to impact the economy, while stocks may see an immediate impact. In general, higher interest rates tend to negatively affect profit and stock prices, while there are exceptions in the financial sector. For investors, any changes in interest rates, rises and decreases, means strategizing their next financial move to protect their investments

Effects on Inflation and the Federal Budget

Interest rate hikes are meant to tackle high inflation rates. And so when these rates are increased, although it takes some time, inflation rates do tend to decrease. Although hikes in interest rates can be positive for combating inflation, they aren’t good for the Federal budget. The Federal government will have to pay more money on its national debt, just like the rest of the country, and that takes away funding from other important objectives, policies, and departments. 

Factors Influencing Federal Reserve Interest Rate Hikes

Here is a breakdown of the different factors that the Feds pay attention to when deciding to increase (or decrease) interest rates:

Economic Indicators

Economic indicators are a variety of variables that provide insight into what direction the economy is headed in. Indicators include income, employment, production, gross domestic product, income, business activity, security markets, international statistics, Federal finance, production, money, and credit. 

Inflation

The Federal Reserve defines inflation as a gradual rise in the cost of goods and services over time. To assess inflation rates and anticipate future patterns, economists utilize seven distinct tools. These tools primarily evaluate fluctuations in the pricing of goods and services across multiple sectors, including but not limited to food, energy, healthcare, and living expenses in various regions.

Inflation also causes a decline in purchasing power, which refers to the number of goods and services an individual can buy with a given dollar amount. Consequently, a lower inflation rate leads to a greater purchasing power of money, whereas a higher inflation rate results in a reduced purchasing power.

Employment and Wage Growth

And finally, employment and wage growth are additional important factors that the Feds will pay attention to when determining whether a hike or decrease in interest rates. Employment refers to the employment rate—the measure of the extent to which available labor resources are being used. Wage growth is an adjusted measure of wage growth for inflation. An increase in wage growth usually correlates to price inflation, while a decrease means the opposite. 

Monetary Policy and Federal Reserve Interest Rate Hikes

Monetary policy is the set of actions that control the nation’s supply of money. The Federal Reserve controls these actions. The goal of monetary policy is to provide a stable and prosperous economy which is done by promoting maximum employment, moderate long-term interest rates, and stable prices. There are several different tools that are used in monetary policy, including: 

  • Open Market Operations
  • Term Deposit Facility
  • Discount Window and Discount Rate
  • Interest on Reserve Balances
  • Overnight Reverse Repurchase Agreement Facility
  • Central Bank Liquidity Swaps
  • Reserve Requirements
  • Foreign and International Monetary Authorities (FIMA) Repo Facility
  • Standing Overnight Repurchase Agreement Facility

When it comes to the relationship between monetary policy and interest rate hikes, several different tools may be used. However, the interest on reserve balances is the major tool used to increase interest rates. 

Economic Implications of Federal Reserve Interest Rate Hikes

There are definitely implications of Federal Reserve interest rate hikes on different parts of the economy. GDP stands for gross domestic product, and when interest rates rise, it causes GDP growth to decrease. The Fed’s interest rate hike will also impact the unemployment rate. Generally, the unemployment rates will see an increase, as higher rates cause hiring to go through a cool-down period. Business investments tend to slow down as interest rates increase. 

Interest Rate Hikes and Consumer Spending

When interest rates hike, it slows down consumer spending. This happens for a few reasons, the cost of borrowing funds goes up, and many people cannot or do not want to pay extra to borrow funds. Additionally, higher interest rates affect consumer and business confidence by discouraging risky investments and purchases. 

Frequently Asked Questions

Here is some information about topics that come up regularly when discussing interest rate hikes:

Frequency of Interest Rate Hikes

There really aren’t limitations set up to the number of interest rate hikes that the Feds can conduct. As of the past year or so, there have been 10 consecutive hikes. 

Decision-Making Process for Interest Rate Hikes

The decision-making process of the Federal Reserve involves meetings with leaders of the Federal Open Market Committee (FOMC) that come together to discuss the current state of the economy and set a monetary policy based on the economy’s best interest. Usually, these meetings happen eight times a year.

Communication of Interest Rate Decisions

The Feds often communicate their interest rate decisions to the nation because it adds transparency, which has several benefits and is essential to the success of whatever monetary policy the Federal Reserve is trying to implement at the moment. 

The Federal Reserve’s Authority

Although the Federal Reserve can change the interest rate they charge for their balances, they do not have the authority to dictate how much money other banks charge each other. However, they are able to set a target federal funds rate which then directly affects other interest rates. 

The Federal Reserve does control the supply of money in the United States, but it does not have the authority to print money; only the Treasury Department’s Bureau of Engraving and Printing can do so. 

Conclusion

Whether you are a consumer, business owner, investor, or all three, it is essential to understand the implications and impact of interest rate hikes by the Federal Reserve. These hikes impact several aspects of the economy; they make borrowing money more expensive, slow down spending and investing, help fight inflation, and take away from the federal budget. Once you understand what interest rate hikes mean and why they happen, you can understand the current state of the economy, which can help you make informed financial decisions.

 

 

 

References:
Economic Indicators – CEA | The White House
Employment rate | OECD Data
Monetary Policy | Federal Reserve Board
Policy Tools | Federal Reserve Board
Pros and cons of Fed raising interest rates | CNBC
Fed Raises Interest Rate | CBS News
How the Fed Implements Monetary Policy with Its Tools | St. Louis Fed
The Impact of Interest Rates on Federal Interest Costs | Summit
Why do Fed officials communicate with the nation so often? | Federal Reserve Bank of SF
How Do Interest Rates Affect the Stock Market? | Investopedia
Fed’s Interest Rate History: The Fed Funds Rate Since 1981 | Bankrate

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