The Role of the Federal Reserve
The Federal Reserve (often referred to simply as “the Fed”) is the central banking system of the United States of America. One of its main functions is to control the supply of money. To that end, the Fed has the authority to make interest rate adjustments during periods of spiking inflation.
Stabilizing prices is an important part of the Fed’s mandate, and the goal is to settle disruptive economic conditions while keeping unemployment low.
The impact of increasing interest rates on credit
When the Fed increases interest rates, the cost of loans and other credit products becomes more expensive, both for individuals and businesses. The move sparks a jump in the Prime Rate, which is the most commonly used short-term interest rate in the United States.
Banks offer the Prime Rate to their best customers, so when that interest rate rises, so does the rate those lenders can offer you, the prospective borrower. Therefore, everyone who takes out a loan or uses a credit card and keeps a balance will end up spending more on interest fees.
Raising interest rates is a delicate process, however. If the Fed increases rates too quickly it can hurt consumer demand. The result can be a slower than desired economic recovery, which can lead to higher unemployment.
Why the Fed is taking action now
In January of 2022, the consumer price index soared by 7.5%. It was the fastest gain since February 1982. In an astonishingly short time period, consumers across the country discovered that the prices on all sorts of things they normally bought were higher than they had been just months earlier. Sticker shock was impacting the ability of millions of Americans to pay for everything from essentials to luxuries.
In response, the Fed turned to raising rates as a means to control inflation. The action is intended to slow down the economy by making borrowing more costly. The desired effect is to cool consumer demand until prices stabilize.
How you can best react
Consider this time an inspiration to reevaluate your own finances so that you can make ends meet today while also preparing for the future:
- Add to your income. If possible, find ways that you can increase your earnings, at least on a temporary basis. Consider taking on part-time work, entering the gig economy, explore a better paying job, or even if you have adult children who are living with you, ask them to contribute to the household.
- Reduce or eliminate costs. Go through your budget with a fine-tooth comb. Lower or get rid of expenditures that you don’t need or care about. Commit to becoming a better shopper, paying close attention to sales and deals.
- Save whenever possible. When you have refined your budget, try to make room for a fixed savings amount. Have that money automatically deducted from your checking account and deposited into savings. Even a small sum you set aside on a regular basis will add up over time.
- Borrow mindfully. While it’s never a good idea to accumulate consumer debt, especially on high-interest credit cards, it is especially important now. Only charge what you can and will repay in full by the due date.
- Keep your credit in good shape. If you do want to take out a loan for a home or car, you will get the best interest rate by building and maintaining a good credit score. That means paying all accounts that appear on your credit report on time and keeping revolving debt low.
As a consumer, you have no control over a store’s prices, a bank’s interest rates, or what the Fed does to manage either. The cost of borrowing money will likely remain higher than you prefer until the Fed makes the decision to lower rates. How quickly reductions in the price of goods and services will take is unknown. What you do have is command over the money you earn, spend, save, and borrow.