For the past year, the Federal Reserve has been raising the key fed funds rate to its highest level in more than 16 years. Have you wondered why and how it can affect you? Here’s the 411 on interest rates.
In simple terms, Interest rates They are the cost of borrowing money or the return you receive from saving money.
When you borrow money, you agree to repay the principal amount plus interest over a set period of time. The interest rates paid by the consumer are generally stated as the Annual Percentage Rate (APR), which is the rate you pay for a full year (annualized), rather than just a monthly rate/fee.
When you save money, the bank pays you interest on the balance in your account. Annual percentage yield (APY) is the interest rate earned for a full year (annualized) for savings accounts and Certificates of Deposit at financial institutions.
When interest rates are lower, borrowing money is cheaper, making it easier for you to get loans for large purchases like a house or car. On the other hand, this also means that the yield on savings accounts is lower, making saving money less attractive.
On the other hand, when interest rates are higher, borrowing money is more expensive, making it more difficult to obtain loans. On a positive note, these rates generate higher returns on savings accounts, making them more attractive for saving money.
The Fed is raising rates to reduce inflation, or the annual increase in the price level of goods and services. By 2022, the inflation rate exceeded 8%, peaking at 9.1% in June 2022, which meant that the price of “a basket of goods and services” was 8% higher in 2022 than in 2021. This was the highest annual inflation rate since 1981!
By raising rates, the Federal Reserve is raising borrowing costs to reduce the amount of money moving through the economy and reduce demand for the “basket of goods and services.” With higher interest rates, there will be less demand for goods and services, and the prices of those goods and services should fall. In fact, in April 2023, the inflation rate had dropped to 4.9%, so the rise in interest rates is working. The Federal Reserve’s goal is to bring inflation down to about 2%, which was the inflation rate in 2019, before the COVID pandemic.
The numbers and financial terminology can be quite overwhelming. Good job tuning in! You have learned or reinforced one of the most important concepts you can use in your financial journey.
The publication The Ups and Downs of Interest Rates first appeared on OneUnited Bank.