The United States is embarking on a new chapter in its economy with the Federal Reserve raising its benchmark interest rate. In July 2023, the federal funds effective rate surpassed 5%, marking a significant shift after four decades. Economists predict that as interest rates continue to rise, financial conditions will return to a more normal state.
“The prolonged period of zero interest rates is highly unusual,” remarks Roger Ferguson, a former vice chair at the Federal Reserve. “Frankly, nobody expected us to reach this point.”
Previous financial crises have solidified the resolve of past Fed policymakers to push interest rates to their lowest limits and keep them there for extended periods. However, these actions have disrupted the fundamentals of personal finance and business in the United States.
For instance, the unconventional policies of the Fed have hindered the profitability of safe investments for investors. Low interest rates result in minimal yields for government bonds, Treasury securities, and savings accounts. On the other hand, the value of stocks, homes, and Wall Street firms that thrive on debt increases with low interest rates.
As the Fed raises interest rates, safer investments may become more rewarding. However, old investments, particularly those financed with variable loans that are linked to interest rates, could turn sour. Consequently, a wave of corporate bankruptcies is sweeping through the country.
“In this high interest rate environment, there is a constraint on nonproductive investments that may not generate sufficient revenue,” explains Gregory Daco, chief economist at EY-Parthenon. “This is a stark contrast to a low interest rate environment where money is easily accessible, making any investment seemingly worthwhile due to the minimal cost of capital.”
In recent years, economists have been debating the pros and cons of the zero lower-bound policy. With the Federal Reserve increasing the federal funds rate, policymakers caution that rates may remain high for an extended period, even if inflation continues to decrease.
“Unless a catastrophic event occurs, it is unlikely we will see lower interest rates anytime soon,” states Mark Hamrick, Washington bureau chief at Bankrate.com.
To learn more about the unfolding economic era in the United States, watch the above video.
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