When you think of a healthy economy, what comes to mind? Job creation, wage growth, big bonuses? How about rising interest rates? To prevent irrational economic growth derived from cheap credit, central banks will need to increase the borrowing rate.
When an economy is growing too fast it spells trouble for businesses and consumers. This is usually indicated by high inflation, or less purchasing power for goods and services, and easy access to credit. For monetary policy, balance is the name of the game. A fine balance between a growing economy and rational borrowing is the goal. If central bankers are effective, periods of economic booms and busts will be muted.
One effective way to manage economic growth and prevent irrational spending is to make a few subtle changes in interest rates, or the amount you are required to pay for borrowing money.
How would a rise in interest rates affect me?
An increase in borrowing costs would impact everyone. Let’s look at credit card use to explain the situation.
For many families, the advent of a credit card is a welcome feature. It’s always nice to be able to pay for something when you might not have the cash on hand to cover the cost. But recently, there is concern Americans have become too reliant on credit cards. Spending on American credit cards soared last year to $3.5 trillion. Furthermore, U.S. household debt is rising at its fastest rate since 2007, right before the great recession.
With so much debt outstanding in America, consumers are more vulnerable to interest rates than ever before.
Higher interest rates would create higher monthly payments for goods that you purchased with credit. This would impact your budgeting as your paycheck may not take you as far as it usually does. Mortgages, credit cards, auto loans and any other asset purchased with credit is susceptible to higher payments when interest rates rise.
The foot is on the gas for the American economy. But it’s important not to get too excited when it comes to spending. If you receive a tax refund this year or see a decrease in your tax liability, use that money to pay off any outstanding debt you have or put it towards your savings. If you can prevent the urge to spend money now, you will be better off in the long run.