What Does It Mean When The Federal Reserve Cuts Interest Rates?


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We hear all this talk about how the “Feds are lowing rates again today” on the news a lot recently, and that we’re falling into a recession. But what does all that mean? How does that help me in the situation I’m in? What do I do now as far as investing?Well, to put it simply, when the feds lower federal fund rate, it reduces what it costs banks to borrow money from them. When the banks costs go down, banks typically trim rates for consumers and business borrowers. That encourages businesses to expand and households to spend. Homeowners with adjustable mortgages and consumers with credit cards linked to the prime rate often see their rates move down, which is good.

Why is The Fed pushing rates down hard and fast?

Because the government is seeing a danger that troubles them. The housing market could create a downward spiral that would do widespread damage to consumers and businesses. The main problem comes from several things that get started when home prices start the fall. When home prices fall, it inherently fosters large numbers of foreclosures. That throws a bigger supply of houses onto the market, which in turn push prices down further.

Another problem happens when falling home prices force banks and other lenders to take losses on housing-related investments. They certainly don’t want that because it takes a bite out of their capital and reduces the amount of money they have to lend. That in turn makes it harder for home buyers to borrow, and lending banks to lend. If this housing problem continued for an extended period of time, the damage to banks and consumers could become so profound that the economy plunges into a recession the likes of which we don’t want to see.

How is the government planning on fixing this?

Well, they’ve hacked the interest rate 1.25% over the last 11 days. With this drop in interest rates, combined with a stimulus package from Congress, the hope is that they can stave off the looming recession, which isn’t fun. The goal of doing this isn’t pretty in the short term, but it can significantly limit the damage and keep things from falling into the ocean.

So do I want the Feds to cut interest rates or not?

Well, if you are a homeowners with an adjustable-rate mortgages, you like it. If you have an adjustable rate home equity loans, you like it. If you are a homeowners with a good credit rating and can refinance at lower rates, you like it. If you are a business with a loan tied to the prime Fed rate, you like it. However, if you are investing in CD tied to the prime rate, you DON’T like it. If you have a money market account, which is likely tied to that rate at which banks can borrow, you DON’T like it. If you have a savings account at a bank, you DON’T like it.

Overall there are a lot of pieces to the pie, and a lot of people complain about the setup and what the government is doing, but that is what people do, they disagree a lot. You don’t have a lot of choice in the matter so make the best of it and take advantage of the lower priced stocks, and mutual funds you find when the economy is slow.

Filed Under: adviceCompensationDebtEmergency fundfinancial educationFrugalHouseInterviewsInvestingMutual FundsNet WorthRetirement

  • http://streamingincome.blogspot.com naveedsmind

    But Hank – what about inflation?

  • http://myinvestingblog.com hank

    @naveedsmind – what exactly are you wondering about the inflation? Yes, it’ll likely not be great, but it’ll average out over time; may be higher this year as the dollar goes down, and the rest of the world prices go up, but over time, it should still stay around the 3.1% rate – as long as you’ve still got your job, and you’re still beating that 3.1% on raises per year, you should be good to go. Is that what you’re looking for?

  • Pingback: 17 Economists on recessions, stimulation plans, and what they might mean to you | On Financial Success

  • http://vxcl.org vxcl

    Well like you said, if we are home owners with a mortgage then it would depend on whether it is interest adjusted. But on the bigger front, I would say it get harder these days to know what is happening.I’m not sure I trust what is said whether it is the politicians or the bankers.
    .-= vxcl´s last blog ..Benefits of A Window Registry Cleaner =-.

  • John

    I think in a normal period inflation could have been terrible if this happened, but credit will be extended so slowly and accutely that this monetary tidal wave will not ruin us.

  • http://www.lloydsmetals.com/ Gold

    Great info on this post. Thanks for all the good info!

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  • Betty Merry

    How to get lower credit card interest rate?