The Effect of Federal Rate Cuts on Consumers

Gloria Nye, Bollich, Patricia A., Braud, Emily  |  10/7/2008 12:25:38 AM

What impact does a Federal Reserve rate cut have on me? We hear and read about rate changes, but we don’t always understand how they affect us as consumers. Perhaps we don’t realize how rate changes affect us because the full effect of any rate change is so gradual. Interest rates, in general, don’t change dramatically overnight. The Fed’s rate changes take time to filter down through the economy to consumers. It can take from one to three months for lenders to reduce interest rates following a Fed rate cut.

The Federal Reserve funds rate is a percentage rate that banks charge each other for overnight loans. In general, a rate cut stimulates the economy by making money less expensive to borrowers.

Rate cuts can be good news/bad news scenarios. If you are retired and depend on earning interest on your savings, a rate cut means a lower yield and less income, which hurts you financially. Savings become less productive when interest rates drop on certificates of deposit (CDs) and money market accounts. However, the stock market tends to go higher with announcements of lower interest rates, which helps some mutual fund accounts.

Lenders peg credit card interest to the prime interest rate, which rises and falls with the Fed’s rate changes. A rate cut by the Fed can mean lower credit card interest rates. Lesser charges to variable-rate credit cards will help people who owe money. Auto loans and some mortgage rates can be affected, too. Adjustable rate mortgage resets tend to go up less than they otherwise would have. Fixed-rate mortgages are not affected.

In the larger economy, lower rates make the United States less attractive for foreign investors. That makes our U.S. dollar worth less when compared to other currencies and helps us sell more of our goods as exports, but it also makes the things we import more expensive. There is a concern that when it costs less in interest to borrow money, then more will be spent and purchased, thus there can be higher demand and higher prices, which can lead to inflation.

What’s the bottom line for you as a consumer? Well, it is a mixed bag. In the shorter term, credit may cost you less, but interest income will be less, too. We may be able to sell more abroad, but what we buy from abroad will cost more. Borrowers and investors in the stock market will like paying less to use credit. Retirees won’t appreciate how little they earn on their savings. Consumers will notice the rising cost of imported goods. And if the rate cut disturbs the national financial balance too much and increased spending leads to inflation, then the Federal Reserve rate cut can have a far greater impact for a much longer term. That’s when we may see the Fed increasing the rate.

Consumer tips: Pay off high-cost credit card debt. Consider converting to a fixed-rate mortgage. Reduce purchases of more expensive imported goods.

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