The move by the U.S. Federal Reserve Board to raise interest rates is bad news for people with credit cards, but it's good news for those with savings accounts.
News media focus on the former, and how a rise in borrowing costs have a negative effect on the economy. But rising prices are also bad for the economy, so the puzzle is how to balance the two.
The Fed today boosted its target rate for loans made to major institutional borrowers to nearly 5 percent. This means they can borrow from the Fed at that rate and lend to customers at less than 4 percent, and the difference is profit. And, of course, if retail banks pay only 1 percent on their savings accounts, that's an even bigger profit.
But if financial institutions boost their savings rates to 3 percent, as many already have for longer-term certificates of deposit, customers will save their money rather than pay soaring prices to retailers.
The rise in the cost of borrowing will hurt those planning to buy a house or a car, but for those who already have those things, it won't matter, especially if they are already paid for. Nor will it affect homeowners with fixed-rate mortgages. Why? Because the fixed interest rate they pay is just that -- fixed for the term of the loan. It won't change.
What will change, however, is retail sales in general. They will drop, for two reasons: First, prices overall have been soaring. Second, savings rate have risen. Given the two factors, people will reduce spending and save more.
The consequence, of course, is that as sales decline, the overall economy declines, increasing the danger of an economic recession. That is the problem the Federal Reserve faces whenever it changes interest rates.
It can lower interest rates to stimulate economic growth, which it did several years ago and its key rate was near zero. But when inflation threatens economic health, the Fed raises its key interest rate as a way to bring inflation under control and encourage a more healthy economy.
The trick is to balance the two.
It does not always succeed.
News media focus on the former, and how a rise in borrowing costs have a negative effect on the economy. But rising prices are also bad for the economy, so the puzzle is how to balance the two.
The Fed today boosted its target rate for loans made to major institutional borrowers to nearly 5 percent. This means they can borrow from the Fed at that rate and lend to customers at less than 4 percent, and the difference is profit. And, of course, if retail banks pay only 1 percent on their savings accounts, that's an even bigger profit.
But if financial institutions boost their savings rates to 3 percent, as many already have for longer-term certificates of deposit, customers will save their money rather than pay soaring prices to retailers.
The rise in the cost of borrowing will hurt those planning to buy a house or a car, but for those who already have those things, it won't matter, especially if they are already paid for. Nor will it affect homeowners with fixed-rate mortgages. Why? Because the fixed interest rate they pay is just that -- fixed for the term of the loan. It won't change.
What will change, however, is retail sales in general. They will drop, for two reasons: First, prices overall have been soaring. Second, savings rate have risen. Given the two factors, people will reduce spending and save more.
The consequence, of course, is that as sales decline, the overall economy declines, increasing the danger of an economic recession. That is the problem the Federal Reserve faces whenever it changes interest rates.
It can lower interest rates to stimulate economic growth, which it did several years ago and its key rate was near zero. But when inflation threatens economic health, the Fed raises its key interest rate as a way to bring inflation under control and encourage a more healthy economy.
The trick is to balance the two.
It does not always succeed.
No comments:
Post a Comment