What Fed Interest Rates Mean for Personal Finance
Even if the Fed decided to keep raising interest rates, the effect on your savings accounts or certificates of deposit would be minor.
In December 2015, Federal Reserve chairwoman Janet Yellen, to the surprise of almost no one, announced the federal agency would be raising its target funds rate. For the first time in almost a decade, the central bank of the U.S. would be charging interest on interbank loans, from between 0.25 and 0.5 percent. While the news sent shockwaves throughout the financial industry, the average consumer with a checking and savings account was likely left unfazed.
"Understanding the Federal Reserve is essential to being an informed consumer."
Now, as Bloomberg and others reported, events around the world have caused something of a change of heart in the Fed, which announced Jan. 27 it would not be raising interest rates any further as originally planned. If the first announcement was confusing for the average bank customer, this second proclamation was likely even more befuddling. Was this cause for alarm, or just another market scare? Is the average consumer even directly affected by these contradictory decisions? These important questions all have different answers depending on who's being asked, but they are nonetheless vital to the basic understanding of the way money works in the U.S.
The Fed basics
If you're already lost, don't feel bad. Understanding big economic concepts like this are difficult even for economists, but that doesn't mean these news stories are worth tuning out. In a nutshell, the Federal Reserve is the government agency in charge of the monetary policy of the United States. As Yahoo Finance explained, this means the Fed keeps the nation's private banks in check , and keeps an eye on broad economic trends to determine the best course of action. The Fed's ultimate goal is to keep the nation's economy growing at a steady rate. This means achieving a balance between many factors including employment, inflation and other aspects of the economy.
The primary way the Fed accomplishes this economic balancing act is by manipulating the target funds rate. This is the rate at which the Fed loans money to banks, which they then use to provide financial services to consumers. In times of weak economic growth, like what's been seen in the last several years, the Fed will loan banks money with almost no interest. This encourages banks to issue inexpensive loans, which can help get consumers back on their feet after having lost a job, for example. When the Fed's interest rates are low, so is the interest rate attached to consumer loans like mortgages and credit cards. At the same time, consumers don't stand to earn much from savings accounts.
On the other hand, sometimes the economy can grow too quickly. When the Fed issues cheap loans to banks, inflation can rise, which means the cost of goods and services becomes too much for consumers to handle. To prevent this, the Fed will raise interest rates. This makes consumer loans more expensive, but also makes passive savings more advantageous.
Where the Fed stands now
On Dec. 16, 2015, the Fed decided that the economy was growing fast enough to warrant an interest rate increase. Yellen announced the Fed would begin slowly ratcheting up interest rates throughout 2016. However, the global economy has not seen the same stability the U.S. is experiencing. According to Seeking Alpha, an investment advice website, a lack of strong growth in China and Europe combined with the current low price of oil has made investors worried about the health of the stock market. This means the Fed will reconsider raising rates again until global growth picks back up.
What consumers should do
What does this mean for the average bank user? Not much, according to analysis from Forbes contributor John Wasik. Even if the Fed decided to keep raising interest rates, the effect on your savings accounts or certificates of deposit would be minor and gradual. And if you're ready to join the rest of the financial world in panic over the global economy, don't buy into the hype. Instead, use the opportunity to buy into the stock market, which currently boasts some low prices. As Wasik and many others have said, buying low and selling high is the best, most simple strategy for successful personal finance.
For more ideas on how you might be able to save smart, visit with a banking professional at Vectra Bank.