Why the Fed's Latest Rate Hike Is Very Bad News for Americans

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  • The Federal Reserve just announced a 0.5% interest rate hike.
  • The central bank is driving up borrowing costs despite a decline in inflation.

It's problematic on multiple levels.

The Federal Reserve has raised interest rates seven times this year. And on Dec. 14, it announced a 0.5% interest rate hike.

Note that it hasn't been doing so to make consumers' lives miserable. Rather, the Fed has been trying to solve the problem of rampant inflation. And it's been raising interest rates in the hopes of convincing consumers to start spending less money.

But let's back up for a second. It's a myth that the Fed is in charge of establishing borrowing rates for consumer products like personal loans and mortgages. Rather, the Federal Reserve oversees the federal funds rate, which is the rate banks charge one another for short-term borrowing purposes. But when the federal funds rate rises, it tends to drive consumer borrowing costs upward.

The more expensive it is to borrow, the more consumers are likely to cut back on spending. And if that happens, it could bridge the gap between supply and demand that's been causing inflation to soar since the latter part of 2021.

But rising interest rates could also have very negative consequences. And that's why the Fed's latest move really isn't a positive one.

Things could get ugly

On a basic level, higher borrowing costs are bad for consumers because nobody wants to pay more for a loan or rack up more interest on a credit card balance than they have to. And also, at a time when home prices are so elevated, the last thing desperate home buyers need is to get stuck with higher mortgage rates, which are now twice as high as they were at this time last year.

But on a deeper level, the Fed's interest rate policies could be paving the way to a full-blown recession. And that could hurt consumers far more than higher interest rates on loans and credit cards.

As mentioned earlier, the Fed wants consumer spending to decline -- but to a moderate degree, not an extreme one. The problem, however, is that the Fed can't force consumers to strike that balance. And if Americans wind up getting spooked by higher borrowing rates, they might cut their spending in a meaningful way, leading to a recession.

If a recession hits, it could fuel a massive uptick in unemployment. That could force many people into a situation where they have to borrow money to stay afloat -- all the while getting stuck with extraordinarily high interest rates in the process.

Will the Fed slow down?

The Fed's most recent interest rate hike of 0.5% is less extreme than the previous four 0.75% rate hikes it implemented this year. But still, an increase of 0.5% is significant in its own right. And at a time when many people were hoping for relief on the borrowing front, the Fed failed to deliver.

We can probably expect the Fed to keep moving forward with relatively aggressive interest rate hikes until the pace of inflation slows more substantially. But we should also gear up for a potentially catastrophic aftermath.

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