The silver fox may come bearing gifts this holiday season, as the Fed will (probably) increase the mother of all interest rates—the federal funds rate.
In an attempt to save the economy from the financial crisis of 2008, the Fed dropped the federal funds rate down to effectively zero. For close to seven years, the rate has not budged. Finally, it seems like the Fed is okay with loosening the grip off the economy’s bike seat, and reigning in some of the money in circulation.
Despite a few concerns, the Fed claims that the economy can handle the first of several rate hikes in the interest rate. Chairwoman Janet Yellen’s main beef with increasing the fed funds rate has been with the labor market. However, over 211,000 jobs were created in November, wages have been climbing, and GDP is growing at pre-recession rates.
Awesome. I Don’t Think I Care
Well, the fed funds rate is a pretty big deal. Banks will loan out all the money they can in order to make more profits. Because of that, the Fed requires all banks to keep a certain percentage of all their cash, or reserves, in house. However, if a bank comes up short on their reserves, Wells Fargo, or any other bank, will loan the bank the money at the fed funds rate. If you cannot see how this can trickle down yet, stick with me.
Since the financial crisis, the Fed has engaged in expansionary monetary policy by buying securities from banks, in order to increase their reserves. This incentivized banks to loan out more of their money, putting downward pressure on the interest rate. The cheaper a loan is, the more likely we are to get it.
These lowered rates are passed to all forms of debt in the economy. Credit card interest rates drop. Businesses take out loans to expand their company. Consumers take out loans to buy cars and homes. Financially illiterate couples take out $1,000 loans to buy out the local skating rink for a night. It’s safe to say that #FMBA is due to the super low fed funds rate. But, it looks like it’s time to slow that nonsense down, and maybe rightly so.
Making Money More Expensive Is Good For Poor Me?
It helps us be less poor—kind of. When the interest rate is low, it incentivizes people to spend their money. We would rather take advantage of how “cheap” money is than to just save it. But, if the interest rate is increased, we would rather hold onto, or save, our money, thus allowing us build our wealth.
The expansionary monetary policy works for those that already have wealth. Assets, like real estate and stocks, increase much faster. However, Gen Y’s wealth is stagnant and lagging behind past generations in that department. According to the Wall Street Journal, the median millennial (under 35 years old) has a net worth of $10,400 compared to Generation X’s net worth of $18,200 in 1995, all adjusted for inflation. That 42 percent gap ain’t nuthin’ to fuzz with and is certainly not looking good on our end.
The gap is largely attributed to the rise of student loan debt, but saving is just not all that appealing today. Not making excuses, but in the ‘90s, the fed funds rate was around four percent. Gen X’ers were incentivized to save their money and earn decent interest on their savings. You could purchase a one-year certificate of deposit, or CD, and earn close to five-percent interest on that deposit. Today, the average CD interest rate is at 0.27 percent. We’d be happier spending our hard-earned money at the local watering hole than watching our $1,000 investment make a whopping $2.70. Perhaps with increased rates we could buy more than half a beer with the earnings.
Don’t be too concerned about the rate hike, though. The Fed will probably increase the target fed funds rate by about a quarter or half of a percent at most, and they will repeat these hikes incrementally over a long period. The economic analysts seem happy about the change in direction, but Chairwoman Yellen is a cautious one.
The rate hike is coming at a time where the economy looks strong, but has items for concern beneath the surface. The money pumping has done very little to spur inflation. Additionally, jobs are being created, but we’re not filling them. The labor force participation rate, or the amount of people either employed or actively looking for work, has continually decreased since the recession. Moreover, if the Fed’s rate hike goes sour, it can throw the economy back into a recession. No biggie.
Lucky for us, it won’t hurt as bad because we don’t have much wealth in the first place. But it’s time to start putting money away so we’re not FKD in twenty years.