The Carr Report: Rising interest rates = Falling prices and reduction in workforce

by Damon Carr, For New Pittsburgh Courier

One thing for certain, prices on everything are high—too high! This was before the economy was hit with a blind sided punch by COVID-19. Prices on consumer goods and services are so high in fact that very few people are able to imagine purchasing big-ticket items in cash. Can you imagine paying for a house, car, or child’s college in cash before COVID or now? Probably not! Prices on these items are so high, that people take out loans to purchase them. The monthly payments for housing, transportation, and student loans are so high that people can’t imagine paying for medium ticket items such as furniture, appliances, vacations with cash. So they finance them too. Monthly payments on furniture, appliances, and vacations coupled with monthly payments on housing, transportation, and student loans are so high that people can’t imagine purchasing small ticket items like computers, cell phones, and clothes with cash. So they finance those too. The vicious cycle continues.

Credit fuels are our economy. We have an economy that’s heavily dependent on credit and loans. This is why people are so prideful about their credit scores. 

This doesn’t only apply to people. It applies to businesses too. Office space, office equipment, office supplies, advertising, salaries, and employee benefits are so high for both big and small companies that they take out loans to pay for operating costs and to stay afloat —particularly during lean economic times.

So when the Federal Reserve starts manipulating interest rates in an effort to influence monetary policy, everyone feels it—both people and companies.

The Federal Reserve System is the central banking system of the United States of America. Their primary role is to foster economic growth while maintaining stable prices. The main tool the Federal Reserve uses to foster economic growth and maintain stable prices is raising or reducing the Federal Funds rate. This is the interest rate banks charge other banks to borrow money. When they lower the interest rate, they increase the money supply which increases demand for goods and services. When they raise the interest rate, they reduce the money supply which reduces demand for goods and services. 

The Prime rate is the rate Banks charge their most creditworthy business customers. The Prime rate is also a baseline rate on many loan products charged to everyday people. The Prime rate and many rates move up and down lockstep with the Federal Reserve Rates.

We’re in the midst of the highest inflation this country has seen in nearly 40-years. The inflation rate peaked at 9.1 percent in June 2022.  The inflation rate is currently at 8.2 percent. This means that prices that were already too high are even higher. Over the past 30-years, the inflation rate has averaged 2.6 percent per year.  The Federal Reserve believes that a healthy inflation rate is 2 percent. As a result, they set the target inflation rate at 2 percent. When the inflation rate exceeds 3 percent, it can create inflated assets or asset bubbles.  That’s when prices on an asset increase faster than its actual value. We hear it expressed in terms like housing bubbles. In order to get the inflation rate back down to normal levels, the Federal Reserve have been raising the interest rate.

When COVID struck, the Federal Reserve reduced the Federal Reserve rate in an effort to increase the money supply and stimulate the economy to close to zero at 0.65 percent. For the 6th time this year the Federal Reserve has increased the Federal Fund rate. The Federal Fund rate is currently at 4 percent. Federal Chair Jerome Powell stated that the rate will continue to increase in an effort to bring inflation down.

As a result, financing has gotten more expensive. According to an article posted in Bankrate.com interest rates on various consumer loan products has increased drastically:

  • 30-year fixed mortgage rates: From 3.04 percent to 7.12 percent
  • Home Equity Line Of Credit: From 4.24 percent to 7.30 percent
  • Home Equity Loans: From 5.33 percent to 7.38 percent
  • Credit Cards: From 16.16 percent to 18.73 percent
  • 5-year car loans: From 4.18 percent to 5.63 percent

You’re probably wondering, how might these higher interest rates impact you? The obvious answer is you’ll pay higher interest rates if you’re actively borrowing money. But what is the Federal Reserve motive with raising the interest rates?

Falling Prices: Prices are crazy high on all consumer goods and products. Inflationary prices reduce discretionary income. We feel it at the gas pump. We feel it at the grocery store. We feel when we have too much money left at the end of our money. We see it on the sticker price for a new car. We see it on the listing price for a new home. I think we’d all agree, prices need to come down.  When rates are higher, people are more reluctant to borrow and spend money. This creates less demand for consumer goods and services. Less demand creates lower prices.

Falling prices is what the Federal Reserve is looking for to neutralize inflation. Hopefully we will experience a “soft landing” where we’ll see inflated prices come down but not experience an insane amount of people losing their jobs.

Reduction in workforce: Higher interest rates makes companies more reluctant to borrow money to expand business and hire new employees. With the money supply being restricted due to higher interest rates, it equates to less sales and lower profit margins. The largest expense for companies are employee salaries. In order to combat higher interest rates and lower profit margins, first companies will employ hiring freezes. If things still look bleak, they will employ a reduction in workforce – Job layoffs.

What do you do when prices are high, interest rates are high, and job security may be threatened?

Purchasing items at inflated prices using high interest rate loans and credit cards in an environment where the Federal Reserve is aiming to increase unemployment to combat inflation sounds foolish if you ask me. Don’t do that!

Continue to work hard, only buy what is necessary, and stash cash for a rainy day. Brace yourself, it could be a bumpy ride especially if it’s not a soft landing.

(Damon Carr, Money Coach be reached @ 412-216-1013 or visit his website @ www.damonmoneycoach.com)

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