You asked, we answered: the Fed’s rate hike explained

Marketplace Staff Dec 16, 2015

You asked, we answered: the Fed’s rate hike explained

Marketplace Staff Dec 16, 2015

What is the Fed doing?

In part, the Fed is signalling that the economy is healthy enough to bring rates back up to “normal.”  the Fed dropped interest rates down to their current levels in December 2008, and they’ve pretty much stayed there ever since. The idea is that low interest rates — i.e. making money pretty much free to borrow — would help a floundering economy grow and recover from recession. And now that our economic metrics have improved — the unemployment rate is at 5 percent, for one — the Fed is saying it’s time.

The Fed is starting small, though. It’s likely going to only hike rates by a quarter of a percentage point, and gradually keep raising rates until they get to about 3 percent in 2018.

You wrote on our Facebook page and tweeted using #AskMP about the interest rate hike, here’s some of our responses.

Why now?

Marketplace’s Tracey Samuelson reports that the Fed sees too much peril in keeping interest rates as low as they have been.

“Many don’t remember, but in 1979, 1980, inflation was running near 15 percent, eating up purchasing power and forcing a short-term perspective on business,” said Carl Tannenbaum, the chief economist at Northern Trust.

If interest rates are low, people spend money instead of save, and that drives up prices — i.e. inflation. People also take more risks when it’s inexpensive to borrow, which in the long term could result in bubbles in the stock or housing markets.

We talked to Former Treasury Secretary and current Harvard economist Larry Summers this week on the “why now” question. He said the Fed is raising rates in part because it has to.  He expressed worry about the timing — specifically because he’s worried our economy is still weak, and could go into recession. In short, it’s a bit of a betting game: if the Fed waits too long to raise rates, it could create too much inflation or bubbles. Act too soon, and it could slow down a recovery that’s still potentially fragile.

So how does this work?

Turns out the Fed raises rates differently than it used to. Here’s our explainer.

How does it affect me?

Well, it probably won’t affect you much right away. It’s a small rate increase to start, and this is a long game. But it eventually should get more expensive to to borrow money. The flip side is that, eventually, you’ll get more of a return from the money in your savings account.

A lot of listeners wrote in with questions about what higher interest rates mean for their lives.

Marketplace’s Nancy Marshall-Genzer reminded us that mortgage rates are going to go up slowly.  The Fed’s rate hike is not expected to be like a lightning bolt. The idea is not to jolt the the housing market.

Gregory Daco, chief U.S. economist at Oxford Economics, said he expects interest rates to just creep up, gradually rising to around one percentage point next year, translating to around a half a percentage point rise in 30-year fixed mortgage rates.

Frank Nothaft, chief economist at CoreLogic, said he expects the 30-year fixed mortgage rate to end up at around 4.5 percent by the end of next year. But Nothaft said the economy should be able to absorb that if it grows as expected.  “We should see a rise in incomes and that’ll help to offset the small rise in mortgage rates,” he said.

And here’s the real takeaway: even after they rise, Nothaft said, mortgage rates will still be lower than before or during the recession.

How will a hike effect credit card rates?

“Bad news for anyone holding personal debt. This will hurt, won’t it?” And 

The blowback from rates being next to zero for so long. Minimum payments on revolving credit accounts will go up, right?”

Interesting thing here: your credit card rates might not change much. Marketplace’s Sabri Ben-Achour reports that credit card rates are about the same as they were during the recession.  Part of the reason is what credit cards are.

“Credit cards are unsecured loans,” said Bill Hardekopf, CEO of LowCards.com. Car loans and home loans are typically less risky because, after all, cars and homes can get repossessed. Credit cards don’t work like that, “so if you go out and buy a stereo and you default on your credit card, the credit card issuer cannot come into your house and take your stereo,” he explained.

So your rates may not change in the way you expect.

How much does this really matter?

That’s the real question, right?

Change is hard. But it’s less about the short term rate rise, and more about what happens in the next few years – and if the economy can sustain higher interest rates. As we’ve been reporting, even though the economic metrics in this country are good, there’s no small amount of economic anxiety out there.

We’re here to help you navigate this changed world and economy.

Our mission at Marketplace is to raise the economic intelligence of the country. It’s a tough task, but it’s never been more important.

In the past year, we’ve seen record unemployment, stimulus bills, and reddit users influencing the stock market. Marketplace helps you understand it all, will fact-based, approachable, and unbiased reporting.

Generous support from listeners and readers is what powers our nonprofit news—and your donation today will help provide this essential service. For just $5/month, you can sustain independent journalism that keeps you and thousands of others informed.