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The personal effects of rising interest rates

For the last several months we have felt the sting of rising prices.

Everything we need and want is more expensive. Up to now, the Federal Reserve (a.k.a. the Fed), America’s central bank, was willing to ride it out in the hopes that once the pandemic waned and stimulus checks stopped, demand would settle down and allow supplies to replenish. Well, with prices up over 7% on average year-over-year, the Fed has decided to step in. Today’s newsletter is about what that means.


A popular tool in the Fed toolbox for tamping down inflation is increasing interest rates.

The Fed controls the Fed Funds rate, which is the interest rate at which banks can lend their reserves to each other overnight. Although, this basic definition does not do justice to the power of the Fed Funds rate. A change to this rate has far reaching impacts. It affects financial conditions in the country that can impact things beyond inflation such as employment, economic growth, stock and bond investments, etc.


So how does a change in the Fed Funds rate stop inflation?

It makes borrowing more expensive. An increase in the Fed Funds rate makes car loans, home loans, credit cards, variable student loans, and other forms of debt more expensive. For example, if you have a home equity line of credit, chances are it has a variable interest rate based on the Wall Street Journal prime lending rate. When the Fed Funds rate increases, it causes an increase in the prime rate which means your home equity line of credit will cost you more each month.


But wait... Isn't the Fed trying to make things less expensive, not more expensive? How does this make sense?

Great question. An increase in interest rates makes borrowing more expensive and will slow down consumer spending. As demand decreases, supply will increase and, theoretically, make more goods available at lower prices.


I wish I could say that economics and monetary policy are as simple as what I have laid out for you today, but it's not.

There are always peripheral factors that will influence the effects of this monetary policy. Only time will tell if this commonly used Fed tool will help lessen the financial burden on American families. As a woman with an average American family, I am feeling the pain of inflation too. It can make you feel helpless and victimized by a system that you didn’t create and can’t influence. If you are feeling overwhelmed by what the broader economy is doing to your family’s health and wellness, please reach out and schedule a complimentary consultation. We can work through it together.


All my best,

Christina






Christina Gatteri, CFP

Certified Financial Planner

Warwick, Rhode Island 02886

(401) 203-9749

Christina@MeNextYear.com



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