After reducing rates to record low levels following the economic crisis, the Fed must decide if our economy is healthy enough to allow for an interest rate hike. They did so on Dec. 16. The new higher rates mean that borrowers will have to pay more for borrowing money, and companies that take out loans will also face increased costs.
In general, raising the target federal funds rate is intended to tame inflation and cool an overheated economy. It’s also a tool that can be used to reduce the risk of a recession. But in the process, it can create winners and losers that shift over time, as prices rise or fall and consumers and businesses adjust their spending habits.
Aside from the direct effects on borrowers, savers, and investors in equities, these policy decisions have global impacts. In fact, academic research demonstrates that when interest rates in the US increase, they lead to capital flow reversals in emerging economies, creating instability and often financial crises.
As for the future, a recent speech by San Francisco Fed president Mary Daly suggested that the rate hikes may be coming to an end soon. But Minneapolis Fed President Neel Kashkari has said that rate cuts aren’t off the table, and New York Fed president John Williams emphasized that the unemployment picture is key to determining whether the Fed will raise rates again. Regardless of their views, most Fed officials speak openly about their policy outlook and investors listen closely to their every word. Understanding the reasoning behind these decisions and knowing what to expect can help you make smarter financial choices.