Impact of Rate Hikes Explained

Impact of Rate Hikes Explained

Unless you have been living under a rock, I am sure you have heard plenty of news regarding the increase in interest rates. What are rate hikes, who does this affect, and what are some of the domino effects of the Federal Reserve continuing to increase rates?

Let us start with some Terminology:

Interest Rates: the proportion of a loan charged as interest to the borrower, typically expressed as an annual percentage rate (APR) of the loan outstanding. This is also mentioned with savings accounts. Certain savings accounts offer a specified interest rate of return if you stash your money with their bank. An example of this is a high-yield savings account.

Inflation: the action of inflating something or the condition of being inflated. In economics, this means a general increase in prices and a fall in the purchasing value of money.

Mr. Fed

The Federal Reserve plays a significant role in the economy of the United States.

Firstly, when the Federal Reserve increases interest rates, it becomes more expensive to borrow money. Consumers will be less likely to take out loans for big-ticket items like buildings, homes, cars, and appliances. Spending tends to decrease when people are less willing to borrow money, slowing economic growth. For businesses, higher interest rates mean that borrowing money for expansion or investments is more expensive, leading to slower growth.

Secondly, higher interest rates can lead to a stronger dollar. When interest rates are higher, foreign investors may be more likely to invest in the US, attracted by the higher returns. This can cause demand for US dollars to increase, driving up the dollar's value compared to other currencies. While a strong dollar may sound good, it can make US exports more expensive, hurting American businesses that rely on international trade.

Thirdly, higher interest rates can lead to higher unemployment. As borrowing becomes more expensive, businesses may be less likely to invest in growth and expansion. This can lead to fewer job opportunities and, in turn, higher unemployment. Conversely, when low interest rates, businesses are more likely to invest in expansion and hiring, leading to more job opportunities.

Finally, higher interest rates can lead to lower inflation. When interest rates are high, borrowing becomes more expensive, and people are less likely to spend money. This can cause demand for goods and services to decrease, leading to lower prices and lower inflation. In contrast, low inflation may sound like a good thing, but too little inflation can lead to stagnation and make it difficult for businesses to grow.

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In conclusion, the Federal Reserve significantly impacts the US economy by setting interest rates. When the Federal Reserve increases rates, it can lead to lower spending, slower growth, a stronger dollar, higher unemployment, and lower inflation. While higher interest rates can have some benefits, such as attracting foreign investment, the overall impact can be damaging for the economy. As such, the Federal Reserve must carefully consider the potential impact of increasing rates before making any changes.

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