What Happens When the Fed Raises Rates, In One Rube Goldberg Machine

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I thought retirement planning would be the last topic I wrote about for the year, but this is too good not to share. The Fed raised interest rates today for the first time in almost a decade. But what will that actually do to the economy? The NYT did an awesome explanation via a Rube Goldberg machine to show the chain reaction that the Fed's announcement today should set off.

I summarized the highlights below, but it's totally worth taking 2 minutes to check out the video and breakdown here.

  • The "Fed raised rates" meaning it raised its target for the federal funds rate, the rate at which banks lend to each other.
  • The cost of borrowing rises across the banking system and when banks and other financial institutions face higher costs, they pass those costs on to their customers in the form of higher short-term and long-term interest rates
  • Domestic assets like Treasuries and corporate bonds become more attractive to foreign investors because it’s more desirable to hold dollars if you’re receiving higher interest rates. But in order to buy these assets, those investors trade their currencies for dollars, driving up the dollar which is in greater demand.
  • As bonds become a more attractive investment, money flows into the bond market and away from the stock market
  • When banks raise rates, it affects different consumers differently. Taking out an auto loan, carrying a balance on a credit card, or buying a house with a mortgage becomes more expensive. Those with large savings at the bank will get larger interest payments. 
  • People may buy less, if they need to borrow to buy stuff, now that the cost of borrowing is higher
  • If people buy less stuff, the companies making that stuff may see slower sales and may not need to employ so many workers to make that stuff
  • With less demand for their products, businesses will feel less comfortable raising prices, and workers will be in a worse position to demand pay raises. Together, that means prices will rise even more slowly than they otherwise would across the economy. In other words, higher interest rates, after all that, have translated into less inflation.