At this point, you likely know inflation has been hitting historic highs worldwide. In the U.S., a gauge known as the Consumer Price Index (CPI) indicates that
And it's not just inflation that's increased—both inflation and interest rates have moved sharply higher, which is no coincidence.
How does rising inflation affect interest rates?
Generally speaking, modern economic theory suggests that inflation is driven by supply and demand. Rising inflation indicates there is more demand than supply for goods and services, which are increasing in price.
The Federal Reserve has tools to help control inflation if it's showing signs of persistence.
One such mechanism is raising the federal funds rate, which is the interest rate that banks charge each other for lending or borrowing reserve balances overnight. This benchmark interest rate directly or indirectly influences other interest rates, including rates for credit cards, car loans, student loans, mortgages, certificates of deposit and savings accounts.
In the meantime, the Fed is busy analyzing economic data, including trends in prices and wages as well as consumer expectations about inflation over time, to determine how much to raise rates and how frequently. It's a delicate task since hiking rates can solve one problem while causing many others.
Why are rising interest rates an issue?
Because consumer spending represents approximately two-thirds of U.S. GDP, increasing interest rates and thereby reducing consumer spending too much can contribute to a
One historical example that serves as a cautionary tale is the
Even if raising rates doesn't have such dramatic consequences, any intended cooling of economic activity can have negative repercussions for workers. The International Monetary Fund, for example, expects that reduced demand could
Climbing rates can have ripple effects on consumers' finances that go beyond layoffs and lower wages.
Consider 30-year fixed-rate mortgages, which aren't directly tied to the federal funds rate but
What positives come from higher interest rates?
While higher interest rates can be costly for borrowers, the opposite may be true for savers. Yields on certificates of deposit (CDs), savings accounts, money market funds and bonds generally rise when the Fed raises interest rates, putting more money into the pockets of savers or investors.
Reach out for guidance
It's important to try as best as you can to wisely manage your finances during this volatile and confusing period. However, sometimes you might need a little help.
If you've been putting off a large purchase that simply can't wait any longer, or if you can't pay your credit card bills and you're concerned about the mounting interest, you might want to