When the Federal Reserve “raises interest rates” it actually raises the target federal funds rate. The federal funds rate is the rate at which financial institutions lend money to each other overnight. The target federal funds rate is set by the Federal Open Market Committee (FOMC) which meets eight times a year.
The FOMC doesn’t actually set the rates that you see advertised by banks. Rather the FOMC’s target affects the federal funds rate which in turn affects other short-term interest rates. The rates you see advertised are influenced by the federal funds rate but they’re not determined by it.
When the FOMC raises the target federal funds rate you’ll see an increase in other short-term interest rates like the prime rate and variable- and adjustable-rate loans. You may also see an increase in long-term interest rates like bonds and fixed-rate mortgages.
The Feds raising interest rates can have different implications depending on whether you’re a borrower or a saver.
If you’re a borrower a Fed rate hike means that your interest payments will go up. This is because when the FOMC raises the target federal funds rate banks will likely raise their prime rates. And when the prime rate goes up so do the rates on variable- and adjustable-rate loans. If you have a fixed-rate loan your payments won’t go up but you may have a harder time qualifying for a loan because the rates on new loans will be higher.
If you’re a saver a Fed rate hike means that the interest you’re earn on savings accounts CDs and money market accounts will go up. That’s because when the FOMC raises the target federal funds rate banks usually raise the interest rates they pay on deposits.
The FOMC doesn’t raise rates to control inflation; rather it tries to manage inflation expectations. The thinking is that if inflation is expected to be low businesses and consumers will borrow and spend more which can lead to actual inflation.
The FOMC also raises rates to prevent the economy from overheating and growing too quickly. If the economy is growing too quickly it can lead to inflationary pressures. To slow the economy down and keep inflation in check the FOMC will raise rates.
The FOMC uses a variety of tools to influence interest rates and the economy but the federal funds rate is the most direct way it affects short-term rates.
Why might the Federal Reserve raise interest rates?
Answer: There are a few reasons why the Federal Reserve might raise interest rates.
One reason is to slow down the economy and prevent inflation.
Another reason is to try to attract more foreign investment into the United States.
How does a higher interest rate affect consumers?
Answer: A higher interest rate will generally make borrowing more expensive for consumers.
This could lead to people cutting back on their spending which would in turn slow down the economy.
How does a higher interest rate affect businesses?
Answer: A higher interest rate will make it more expensive for businesses to borrow money for expansion.
This could lead to businesses hiring fewer workers or slowing down their production which would also slow down the economy.
How does a higher interest rate affect investors?
Answer: A higher interest rate can make investing in the stock market less attractive and may cause investors to put their money into other investments such as bonds or real estate.
How does a higher interest rate affect the housing market?
Answer: A higher interest rate will make it more expensive for people to get mortgages and may cause people to put off buying homes or investing in the housing market.
How does a higher interest rate affect the economy?
Answer: A higher interest rate can slow down the economy by making borrowing more expensive for consumers and businesses.
This can lead to people cutting back on their spending and businesses hiring fewer workers or slowing down their production.
What is the Federal Reserve’s main goal when raising interest rates?
Answer: The Federal Reserve’s main goal when raising interest rates is to slow down the economy and prevent inflation.
What is inflation?
Answer: Inflation is when prices for goods and services rise.
This generally happens when the economy is growing too quickly and there is more money chasing after fewer goods and services.
How does the Fed fight inflation?
Answer: The Fed fights inflation by raising interest rates which makes it more expensive to borrow money and usually slows down the economy.
What is the downside of fighting inflation?
Answer: The downside of fighting inflation is that it can slow down the economy and cause recession.
What is the main goal of the Federal Reserve?
Answer: The main goal of the Federal Reserve is to promote stability in the economy.
How does the Federal Reserve promote stability in the economy?
Answer: The Federal Reserve promotes stability in the economy by keeping inflation in check and by helping to ensure that there are enough jobs for people.
What is the full employment goal of the Federal Reserve?
Answer: The full employment goal of the Federal Reserve is to promote maximum employment in the economy.
How does the Federal Reserve promote maximum employment?
Answer: The Federal Reserve promotes maximum employment by keeping interest rates low and by ensuring that there is enough money in the economy.
What is the downside of the Federal Reserve’s full employment goal?
Answer: The downside of the Federal Reserve’s full employment goal is that it can lead to inflationary pressures in the economy.
