At the onset of the coronavirus pandemic, the U.S. Federal Reserve slashed interest rates to zero. By manipulating this federal funds rate, the Fed can massively impact the economy. It’s common for the Fed to cut rates during economic downturns and raise rates during booms.
In September, the Fed not only pledged to maintain low-interest rates for the time being, but some members said they believed interest will remain at or near zero through 2023. That could have significant sway over how America’s economic recovery shapes up, as well as how your wallet looks.
Why The Fed Is Keeping Rates at 0
The Federal Reserve moves interest rates for various reasons, but there are a few general things to know. When interest rates are low, it’s cheaper to borrow money. That contributes to falling loan rates, mortgage rates, etc. Ideally, as borrowing and spending get cheaper, the economy enjoys an influx of capital.
Before getting any deeper, it’s important to note that interest rates, inflation, and unemployment are all statistically related. As interest rates go down, inflation tends to go up and vice versa. Inflation also has an inverse relationship with unemployment. When unemployment is too low, inflation can run wild. While these links aren’t perfect or exact, we know they exist. Understanding these basic principles is key to getting what the Fed is trying to achieve.
(For a deeper dive on the ins and outs of the Federal Reserve, check out our explainer on it!)
In today’s economy, inflation is well below average. Optimal inflation is supposedly around 2 percent, but the inflation rate has been 1.5 or lower every month since March. On average, inflation rates have remained below 2 percent since the 2008 economic crisis, which was also the last time the Fed slashed rates to zero.
By keeping interest rates low for years, the Fed is actually hoping inflation increases, which seems confusing. In fact, the Fed is hoping to spur inflation back up above 2 percent to create a more stable economic playing field.
Unemployment is well above average but dropping, down from 15 percent in March to around 8 percent now. The ideal unemployment rate in the country is around 4 percent, so we still have a long way to go. Since unemployment is likely to remain unusually high for a while, the Fed has little fear of inflation shooting up, and is thus more willing to keep rates low.
“Many find it counterintuitive that the Fed would want to push up inflation,” Fed Chair Jerome Powell said in a statement. “However, inflation that is persistently too low can pose serious risks to the economy.”
How It Impacts You
Aside from all the technical mumbo-jumbo, so what? How does the Fed keeping interest rates low impact the average American? It depends on your current situation, but the consequences could be huge.
For starters, borrowers gain a major boost when interest rates are low.
If you’ve tried looking for a home lately, you may have noticed that mortgage prices are virtually lower than ever. That’s at least in part due to the Fed slashing rates. Historically low mortgage rates translate to unusually high purchasing power for consumers, meaning now is one of the best times to buy a home. Current homeowners can look to refinance their mortgage at a much lower rate, and find significant savings.
Credit card debtors are better off with low-interest rates low. Since most credit cards are a variable rate, their interest shifts toward the Fed’s rates. According to a WalletHub study from August, credit card interest rates have dropped roughly 1 to 2 percent since March. If you’re in debt now, that means interest accumulates more slowly and you have an edge on paying your bills. If you’re looking for a new credit card, it means you can secure a great rate when opening.
Federal student loan interest rates hit historic lows during this pandemic as well. In short, borrowers benefit, but savers beware. Banks may cut interest on savings accounts, forcing you to reconsider your saving options or move your money elsewhere to grow.
The Bottom Line
By moving interest rates, the Federal Reserve can exercise influence over the economy at large and drive certain monetary goals. Presently, the Fed hopes that keeping rates as low as possible will drive inflation back to normal, and since unemployment remains higher than usual there should be no negative side effects on the job market.
That boils down to a situation better for borrowers and spenders, but worse for savers and stashers. Still, like the Fed itself, you can tweak your personal monetary policies as things change to make the most out of a shifting landscape!