By Craig Erwin, Ph.D.
The fed funds rate dictates the interest rates banks pay the Federal Reserve, the U.S. Central Bank, when they borrow money. The fed funds rate also affects the interest rates you pay when you borrow money from a bank or credit card company. Last year the Federal Reserve jacked up interest rates, trying to slow the economy and rein in inflation. Less than a year ago the fed funds rate was 0.25%, but now it’s 4.25%-4.5%, according to Forbes.com. That may sound high, but it has been much higher.
Paul Volcker, chairman of the Federal Reserve from 1979 to 1987, raised the fed funds rate to 20% four times in the early eighties, according to the Balance. Why? Because drastic steps were needed to stop runaway inflation. Volcker felt he had no choice, so he raised rates sharply, trying to slow the economy. Thankfully, his aggressive measures worked; record high interest rates convinced individuals and companies that borrowing at such high rates was unwise. The economy slowed and inflation reversed course. The result was a nasty recession, but that was a fair price to pay to keep inflation from doing even worse damage.
Although today’s interest and inflation rates are high compared to last year’s rates, they have been much higher, as in the 1980s. We have been spoiled by low inflation and interest rates for so long that we were all taken by surprise when the rates shot up last year. According to Nerdwallet.com, the average interest rate for a 30-year fixed-rate home loan is 6.92%. This may sound steep, but not to those of us who had mortgages with double digit interest rates in the 1980s.
In the end, you can’t change interest rates or the rate of inflation. Interest rates and inflation will continue to rise and fall. You can change your perspective and your actions, though. You can either wait or rush to buy a house or car, depending on your priorities and financial situation. If buying now will stretch you too much, perhaps wait for interest rates to fall. Unfortunately, though, low interest rates may come with high prices. I guess you can’t have everything.
How have interest rates and inflation affected you? Have you had to make lifestyle changes?
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