Federal Reserve

Why interest rates are a big deal?

Jeremy Powell, Chair of the Federal Reserve (aka the Fed), the central bank of the United States, will be giving his interest rate decision in a few hours. It will be one of the most watched commentaries with financial market participants trying to assess whether this is the beginning of the end of interest rate hikes and eventual reduction in rates. 

Recently the Fed raised its benchmark interest rate by 0.75%, the second hike of this magnitude in just two months. This move is part of the Fed’s strategy to combat inflation, which has reached record levels in the past year.

But what are the consequences of higher interest rates for the US economy and beyond? 

In this blog post, we will explore some of the effects that interest rate changes have on various sectors and actors, such as consumers, businesses, government, and developing countries.

Consumers: Higher interest rates mean higher borrowing costs for consumers who want to buy a home, a car, or use credit cards. This can reduce their spending power and demand for goods and services. Higher interest rates also affect savings accounts, as they offer higher returns for savers who want to earn more on their deposits.

Businesses: Higher interest rates make it more expensive for businesses to borrow money to invest in new projects, expand production, or hire more workers. This can slow down economic growth and innovation. Higher interest rates also affect corporate profits, as they increase the cost of servicing existing debt and reduce future cash flows.

Government: Higher interest rates increase the cost of financing public debt, which is already at a high level in the US. According to one estimate, the total budget deficit from 2022 to 2031 will be $12.7 trillion . Higher interest rates also affect fiscal policy, as they limit the government’s ability to stimulate the economy through spending or tax cuts.

Developing countries: Higher interest rates in the US can have spillover effects on developing economies in several ways . First, they can reduce US demand for imports from these countries, which can hurt their export-led growth. Second, they can attract capital flows away from these countries, as investors seek higher returns in safer US assets. This can cause currency depreciation and financial instability in emerging markets. Third, they can increase borrowing costs for these countries that rely on external financing from international institutions or markets.

In conclusion, interest rate hikes in the US have significant impacts on various aspects of the economy both domestically and internationally. While higher interest rates are intended to curb inflation and maintain price stability, they also entail trade-offs and challenges for different sectors and actors.