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Federal Funds Rates Effect on American Households

Lee Bernstein, Faith Pinho, and Benjamin Schaeffer

The Federal Reserve made headlines last week for its decision to raise the federal funds rate, indicating confidence in a strengthening economy. The Fed increased the interest rate to a range of 1.5 - 1.75 percent. Previously, the range was 1.25 to 1.5 percent. The unanimous decision by the Federal Open Markets Committee to raise the range by a quarter percentage point will affect several sectors in the short-run American economy. As Heather Long wrote in the Washington Post last week, “As the Fed boosts rates on financial institutions, banks turn around and lift interest rates on credit cards, auto loans, small business loans and home mortgages.” In this post, we will look specifically at how the Fed’s interest rate hike will impact credit cards, home mortgages and auto loans.

For many Americans, credit cards an important component of their financial portfolio. It enables many households to make larger purchases that they might not ordinarily be able to make. When the Federal Reserve raised its interest rates this week, many Americans do not realize they will be directly affected. The variable interest rates on most credit cards are tied to the prime interest rate which is determined by financial institutions and is directly correlated to the federal funds rate, which the Fed just changed. There will be increase almost equivalent to the change in the federal funds rates.

Another component to pay attention is the effect of the Fed changing interest rates on auto loans. USA Today, when discussing the market, said “they’re still benefiting from a highly competitive market for auto loans that’s keeping borrowing costs low”. This suggests that this specific change to interest rates may not have as large of an affect on car loans as it could. The same article pointed out that old car loans would not be affected by this change in interest rates. An AutoNews article discussed the car purchasers that will feel this changes are “the ‘marginal buyer’ with poor credit ‘is going to have to take that walk over to the used-car lot.’” So, not every American will be hard hit or feel the affect equally.

For homeowners with adjustable mortgage rates, they can expect a rise in their monthly mortgage bills. A singular rise in the federal funds rate would not significantly impact the mortgage rate, but this week’s rise -- in tandem with the two other expected hikes in 2018 -- would truly impact homeowners’ monthly payments. Economists at CNBC predicted that the average mortgage rate could rise from 4.58 percent to 5 percent by the end of the year. “Although your bills might not change too much after Wednesday's bump,” journalist Emmie Martin writes, “things can start to add up after a few more.” To avoid rising rates, Martin recommends switching to a fixed-rate mortgage. Current rates are favorable enough to justify making the switch.

Many industries will be affected by the Federal Reserve’s recent changes; however, as discussed in class, it will take up to two years to see the full effects of the interest rate increase. As the New York Times mentions, during this FOMC meeting, it was “signaled the central bank is set to raise it at least two more times this year”. But, the same article goes onto say how, these increases means that there is an “increased expectation for economic growth”. Like class discussion brought up, this increase sheds insight into Jerome Powell’s mindset given that this was his first FOMC meeting as president of the Federal Reserve.

12 thoughts on “Federal Funds Rates Effect on American Households

  1. ingramk20

    To what degree do expectations play a role in the efficacy of this? We talked a bit in class last week about how even MP is affected by expectations. If people believe the economy is strong and expect this to continue in the future, this will only result in further economic growth. Would the Fed have to counter this by raising interest rates even higher?

    1. mannm20

      Expectations play a really important role in consumption in how it relates to durable goods like housing and vehicles. I think that the most recent Fed hike in interest rates plays a miniscule role in the effects on the housing market in comparison to the expectations of two more rate hikes by the end of 2018. Could one reasonably say that the actions of the Fed impact the economy less than the anticipated actions of the Fed? How do these two factors combine to impact the economy?

      1. minsong20

        It is interesting that while in theory the major effects are seen in 18 months, the average consumer sees the anticipated rate hikes' effects right now. The anticipations have a strong control over the individual consumer that relied on a variable interest rate.

  2. dodsonm20

    How will this affects actually impact us? You mention how much some of the rates will increase like the mortgage rates but I wonder what that change transitions to in dollars. Another question is how quickly will these affects occur? In class we talked about how monetary policy takes time before the full affects are felt throughout the economy.

    1. bullr20

      An increase in interest rates should lead to a decrease in new real-estate investment, and if they stay high enough for long enough, a decrease in business investment spending as well. This will, theoretically, lead to an eventual decrease in consumer spending. Then again, the effects won't really be felt for a full 12-18 months, and monetary policy will be tweaked and reformed many times throughout that period...

  3. dugganj20

    In the late 1970s, economist Paul Volker implemented a very similar change that resulted in the Fed Funds rate being increased. As a result, banks increased their rates to make loans more expensive to businesses and consumers. While the initial hit was hard, eventually the policy paid off and money streamed back into U.S. markets. It will be interesting to see in two years how this similar shift, written in the post, will affect the economy.

    1. prochniaka20

      I agree with you that it will be very interesting to compare the effects of this policy to the effects of a similar policy put in place almost 50 years ago. It will be curious to see just how big of an effect this change has on every day life.

  4. croughanm20

    It makes you wonder exactly about the ethics of policy like this. You note that "the car purchasers that will feel this changes are “the ‘marginal buyer’ with poor credit" and that they will have to "walk over to the used car lot." Is an economic policy like this feeding off a poorer base to help other Americans, or is this walk over to the used car lot simply a fact of life when ones income is so low?

  5. scottm20

    I find the last implication made- regarding Powell's mindset- interesting as many are currently analyzing his initial moves to find indicators in the direction of the Fed, and rightfully so. In part due to the current political climate, it does not appear there is a real consensus among economists and investors about the direction of the markets nor economy. As some believe there are indicators of an upcoming market correction and stall in economic growth, others still ride the ‘Trump-Train’ while forecasting further growth. It will be interesting to observe the future Fed rate hikes as they will provide the best economic indicator in a time of so much division and politically-motivated biases. While one side claims even more economic gains will be actualized, and the other proclaims doomsday, it will ultimately be fascinating to see this economic turmoil unravel.

  6. montjoyr20

    I read an article in the Salt Lake Tribune that discussed the impact that the new tax bill would have on the individual. Essentially, the article says that the average person will see income taxes fall and property taxes increase slightly. While a decrease in income taxes would result in higher disposable income, would this effect be offset by an increase in credit card interest rates? Are people more likely to save if disposable incomes rise but the cost of transactions also rise?

    1. pollarde

      Undoubtedly, some of that disposable income will be spent on the increased property taxes. It sure will be interesting to see the affects this has on the housing market or whether it makes a significant impact at all.

  7. Mariam Samuel

    It is so interesting that a change so minor as a “quarter percentage” is such a big deal, and can have such a large ripple/ multiplier effect which is so direct to consumers. Usually, I dismiss most similar headlines because I never feel like I will actually see the effects. This is especially one instance most applicable from what we have learned in class about increased interest rates. I would like to see the long term effect of the increased interest rates on housing and auto investment spending.

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