Interest rates play an essential part in our economy, helping to coordinate present and future consumption by sending signals to savers as to how valuable their money could be in the future.
Under conditions of increasing interest rates, borrowing money becomes more expensive for consumers, decreasing their disposable income and possibly leading to either higher or lower prices in the marketplace.
Increased Cost of Borrowing
Interest rates impact consumers in various ways depending on whether they are savers, lenders or investors. Interest rates serve an integral function in keeping the economy going by encouraging borrowing and spending, ultimately fueling economic expansion.
When the Federal Reserve raises its benchmark rate, banks become more costly for lending money – leading to higher mortgage, auto, and credit card rates. Furthermore, inflation can cause these rates to go up as it takes more dollars to purchase products due to reduced purchasing power.
Rate increases can restrict disposable income and spending, thus hampering economic development. Saving habits also change, with individuals being less likely to invest in banks but opting instead for alternative investments like shares – something which increases stock market volatility. But falling rates can help promote savings while encouraging consumer spending – mitigating some of these negative effects of higher interest rates.
Decreased Disposable Income
As interest rates increase, they erode away at how much disposable income households can spend and increase spending less, potentially slowing economic development and stock market returns.
An increase in interest rates may discourage individuals and companies alike from investing their money, especially if it means existing investments will yield less return. This may cause companies to delay plans for expansion which in turn has an adverse impact on the economy as a whole.
Consumers affected by rising interest rates vary greatly, depending on whether their debt is tied to higher rates or savings accounts with a lower yield rate. Consumers with credit card or mortgage debt will experience immediate effects of rising rates; those who only hold savings accounts or CDs may only notice any effect after their next billing cycle has closed; as short-term borrowing (like credit cards and payday loans) tends to use short-term rates such as LIBOR or Treasury bill rates while longer-term lending (home loans and student debt) uses longer-term rates such as 10-year Treasury bond rates for longer term loans/lending needs to make an impactful difference between increased rates rising and rising debt obligations that come due in payment due to increasing rates being paid off over time versus holding cash savings accounts and CDs that pay lower rates when rates change due to being tied with debt tied with shorter term rates tied with longer-term rates increases being seen sooner by paying less interest due on savings accounts/CDs than credit cards/mortgages due to such restrictions on lending/mortgages being tied into immediate impactful bill rates while loans/student debt are tied into 10-year Treasury bond rates instead based upon 10-year Treasury bond rates when applied whereas short term borrowing such as payday loans/payday loans being tied into short-term borrowing contracts tied into monthly billing cycles that might not see impact till later billing cycle payments being due.
Decreased Spending
The Federal Reserve’s interest rate has an effectful effect on savings accounts, credit cards, mortgage rates and investments alike – it serves as the standard that financial institutions use when setting their own rates.
Lower rates make borrowing money cheaper, which may encourage spending, yet may result in higher inflation levels if demand exceeds supply.
High interest rates discourage consumer spending as the cost of goods and services rise, and reduce investment as firms and consumers become less willing to take on debt. The reduction of consumer and business spending reduces aggregate demand which leads to slower economic growth and more unemployment.
Rising interest rates may be detrimental for mortgage holders and car loan borrowers, but can provide savers with greater returns on their money. Therefore, understanding how interest rates impact the economy is essential in making informed decisions.
Decreased Investments
After more than a decade of historically low interest rates, borrowing costs are increasing again, impacting homeowners, car buyers and businesses that rely on debt for investment purposes.
Higher borrowing costs could discourage spending and inhibit economic expansion by prompting companies not to invest in new equipment or hire employees.
Interest rates typically increase when investors anticipate high inflation and robust economic growth, so the Federal Reserve often attempts to push rates lower as part of an effort to stimulate the economy.
Interest rates also impact returns from investments such as certificates of deposit (CDs) and Treasury bonds, typically decreasing bond prices as interest rates rise as new bonds issued at higher rates offer better returns than existing ones. Consumers may also invest their savings into stocks; however, when interest rates increase this may cause the stock market to decrease as companies that rely heavily on debt may need to cut spending back, hurting earnings and decreasing stock values in turn.
