Pros and cons of Fed raising interest rates in today's economic conditions—and how you can benefit (2024)

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Pros and cons of Fed raising interest rates in today's economic conditions—and how you can benefit? ›

Higher interest rates can make borrowing money more expensive for consumers and businesses, while also potentially making it harder to get approved for loans. On the positive side, higher interest rates can benefit savers as banks increase yields to attract more deposits.

The downside of higher interest rates is that they tend to hurt most other types of investments, particularly stocks. The idea behind raising interest rates is that it can help slow down inflation by putting a damper on the market. But slower economic growth usually leads to challenging market conditions.

The financial sector generally experiences increased profitability during periods of high-interest rates. This is primarily because banks and financial institutions earn more from the spread between the interest they pay on deposits and the interest they charge on loans.

Higher interest rates work to reduce inflation by dampening demand in the economy, making it more attractive to save and less attractive to borrow. One result of this is reductions in spending and employment by households and businesses.

Because higher interest rates mean higher borrowing costs, people will eventually start spending less. The demand for goods and services will then drop, which will cause inflation to fall. Similarly, to combat the rising inflation in 2022, the Fed has been increasing rates throughout the year.

On the positive side, higher interest rates can benefit savers as banks increase yields to attract more deposits. The average savings yield is now almost 10 times higher than it was when the Fed first started raising rates, and online banks often offer even higher yields.

A high-interest rate typically tells us that the economy is strong and doing well. In a low-interest-rate environment, there are lower returns on investments and in savings accounts, and of course, an increase in debt which could mean more of a chance of default when rates go back up.

Some sectors within the stock market are more sensitive to changes in interest rates compared to others. Financials benefit from higher rates through increased profit margins. Brokerages often see an uptick in trading activity when the economy improves and in higher interest income from higher interest rates.

Higher rates tend to lead to a more efficient allocation of capital across the economy, steering resources to growing enterprises that can put it to more productive use. Provide more income to savers, retirees in particular, who rely on fixed income.

Inflation allows borrowers to pay lenders back with money worth less than when it was originally borrowed, which benefits borrowers. When inflation causes higher prices, the demand for credit increases, raising interest rates, which benefits lenders.

Are interest rates good or bad for the economy? ›

A higher interest rate environment can present challenges for the economy, which may slow business activity. This could potentially result in lower revenues and earnings for a corporation, which could be reflected in a lower stock price.

The base rate is the main driving force in dictating the interest rates advertised across the savings market. If the base rate goes up, it's likely to increase both the cost of borrowing money and the return savers can get on their nest egg.

A rise in interest rates automatically boosts a bank's earnings. It increases the amount of money that the bank earns by lending out its cash on hand at short-term interest rates.

Cons of the Federal Reserve

The Federal Reserve operates independently of the U.S. government, and its monetary policy decisions are not approved by Congress or the U.S. president. This independence helps the Fed operate free of political pressure, but it also limits the Fed's accountability.

Higher interest rates can't stop the impact of these kinds of things. But they can slow down new causes of inflation that follow on from these shocks. These new causes include things like businesses putting up their prices because they face higher costs themselves.

Rising interest rates affects spending because the cost of borrowing money goes up. So, if you have a mortgage, any type of credit card or a loan, you could end up paying more for the money you originally borrowed. This will mean that you inevitably have less money to spend on goods and services.

By keeping interest rates low, the Fed can promote continued job creation that leads to tighter labor markets, higher wages, less discrimination, and better job opportunities —especially within those communities still struggling post-recession.

Higher interest rates typically slow down the economy since it costs more for consumers and businesses to borrow money.

Besides loans, banks also invest in bonds and other debt securities, which lose value when interest rates rise. Banks may be forced to sell these at a loss if faced with sudden deposit withdrawals or other funding pressures.