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Should You Worry About the Federal Reserve's Interest Rate Hike?

When Fed Chair Janet Yellen announced that interest rates would inch upward for the first time in nearly a decade, it sent ripples through the financial world. But the news probably won't change your day-to-day life.

by Allie Conti
Dec 17 2015, 5:00am

Fed Chair Janet Yellen, who just announced an interest rate hike, on a television screen on the floor of the New York Stock Exchange (AP Photo/Richard Drew)

Wednesday, the Federal Reserve announced that interest rates would be raised for the first time since the iPhone was invented. It's a pretty big deal. Our central banking system was created to deal with financial panics and regulate our monetary policy, and the fact that rates are being raised now—making it slightly more difficult to borrow money—is considered a good indication that our country is headed out of recession.

But yesterday's news is more than an indicator of the country's economic health as perceived by Fed Chairwoman Janet Yellen. It's also something that affects people who, for instance, might want to borrow money for mortgages. But what about people who aren't concerned with that sort of major economic decision? Does this massive financial news have any affect on them? To find out, I called up Jared Bernstein, who's the former chief economic adviser to Vice President Joe Biden. He tried to explain what this all means.

VICE: OK, so what is everyone freaking out about?
Jared Bernstein: The recession began in December of 2007. Around that time, the federal funds rate was between 4 and 5 percent, and as the recession took hold, the Fed shifted into a very accommodative monetary policy, which means they sharply lowered the interest rate they control, which is called the federal funds rate and is kind of the benchmark interest rate for the economy. Lots of other interest rates are set off of that one. They took it down to eventually around 0 by late 2008, and now seven years later they've taken it up a quarter of a point.

What was the strategy in bringing them down so low?
Well, when interest rates are low, borrowing is cheaper. If you make the cost of borrowing significantly cheaper, people might undertake economic projects that they wouldn't otherwise. Anything from a business investor deciding to build a new factory, or a homeowner deciding to re-do the kitchen—those kinds of decisions are gonna be cheaper when interest rates are low.

Related: I Asked an Expert How to Get Out from Under My Mountain of Student Loan Debt

Is there a rate we're working toward that's considered the most healthy?
It moves around a lot based on the economic situation, but I think the way I look at is, "What's the interest rate in a healthy economy, one that's firing on all cylinders?" And that's probably around 3.5 percent

People have been talking about and speculating over this for a while. Are the markets scrambling to react, or was everyone pretty well-prepared?
The height that they undertook today is only a quarter of a percentage point. You'll recall that this is benchmark interest rate, and a lot of other rates are tied to it. So auto loans would bump up a touch, home loans, credit cards, the amount of interest that a bond would pay goes up a little bit. But it's gonna be tiny, and it's gonna take a while. Again, the Fed has been announcing this for a while, and if you look around, you can see a few places that have raised interest rates a little bit in anticipation of the announcement.

By the way, lots of people who have savings accounts have been looking forward to this—particularly retired people who's income comes from interest they earn on their savings accounts. When interest rates are low, they earn very little.

You didn't mentions student loans. Are people in debt going to end up owing more?
Student loans are an interesting case, because if you borrowed from the government, the interest rate is far less sensitive. The government doesn't have the same kind of reaction as a private bank loan. The interest rate [on those] could go up a little bit. Most people have locked in a particular rate, so we could be talking about new loans.

Well, that's a relief for me, at least. What's the atmosphere like on Wall Street?
The stock market is another curious case. You talk about it like it's a person with a brain, but it's a lot of people, not all of whom have much brains. That's a joke. It is fair to say that everyone in the stock market saw this coming. I suspect the market's maybe bounced around a little bit, but there probably wasn't much of a reaction. The market picked up 1 point, 3 points today, that's pretty good. That's the work of the Fed, it's called forward guidance. They tell investors and those in the financial markets what they're gonna do and then they do it. So nobody was surprised. The stock market typically likes inexpensive money. So I think if the Fed were to raise the rates too quickly, they would have a reaction.

So, basically if you're a service worker who lives paycheck to paycheck and doesn't plan on making any sort of investment soon, this will have very little effect on you?
Definitely. A relatively small increase like this, you're not gonna see much change in your daily life. If you pay really close attention, you might see a pick up in some of the interest rates on your credit card. But, yeah, that's basically right.

It doesn't lead to faster inflation. To the contrary, the idea of raising rates is often a tool to reduce inflation. If you think that prices are rising too quickly, you raise the cost of borrowing and that slows down economic activity. The person who was going to renovate their kitchen who I told you about earlier, that goes into reverse.

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