Last week the Federal Reserve raised its federal funds rate by one quarter of a percentage point after the consumer price index soared to 7.9% in February, reaching a 40-year high. It’s the first increase in borrowing costs since 2018 and it will be one of several hikes this year.
Federal Reserve Chairman Jerome Powell spoke on Monday at the National Association for Business Economics’ annual economic policy conference. Powell’s message was clear: the Fed will raise its benchmark rate faster than expected.
What happens when the Fed raises interest rates?
Erica L. Groshen, Senior Economic Advisor at Cornell-ILR, said raising interest rates helps to slow the economy.
“When [the Fed] raises interest rates they make borrowing a little more expensive, and when borrowing is more expensive, people think a little bit harder about borrowing money.”
Raising rates slows down investment, which tends to tamp down prices, she added.
How will raising interest rates affect consumers?
A quarter percentage point increase doesn’t seem like much at first, but experts say this is the first of six more hikes to come this year.
When the Fed raises the federal funds rate, the prime rate also goes up. Banks use the prime rate to set interest rates on loan products.
According to Groshen, fixed mortgage rates will go up over the long term with multiple Fed hikes. Adjustable-rate mortgages (ARMs and HELOCs) will be affected more immediately because many lenders tie their borrowing rates to the prime rate. The increase will also affect auto and student loans.
People thinking about purchasing a house or an automobile will need more money to make that purchase. This will cool the market with consumers thinking twice about paying more money.
On the flip side, higher interest rates can mean higher yields for savers.
Over the past decade, annual percentage rates for credit cards have been relatively stable, with a few fluctuations. According to creditcards.com, shoppers looking for a new credit card this spring and summer, could see high APRs they haven’t seen in years.
If the Fed announces a quarter-point increase at each of their next six meetings, the benchmark rate could increase 1.5 percentage points by December. For example: if your interest rate is 14.25% now, it may increase to 15.75% by the end of the year. If you’re carrying debt on a credit card and making minimum payments, even small rate APR increases can result in more debt.
According to a National Association of Business Economics survey of its member economists, 77% think the Fed’s interest rate policy is too low. NABE members mostly work for businesses in the corporate sector, some are employed by federal reserve banks and government agencies.
Federal Reserve Chairman Powell said, “We will take the necessary steps to ensure a return to price stability.”