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How Does Raising Interest Rates Stop Inflation?

Chris Gottschalk

Chris Gottschalk About The Author

Sep 6, 2022 4:45:00 AM

After years of historically low interest rates, it seems like the Federal Reserve is trying to make up for lost time. They’re raised interest rates three times in 2022, meaning that you’ll be paying more for new loans, as well as loans with a variable interest rate, like credit cards.

Obviously, this is not a popular move. So why is the Fed raising interest rates? According to Fed Chair Jerome Powell, it’s because they’re trying to fight inflation. For most people, though, this answer brings up another question, namely how do interest rates have anything to do with inflation?

What Happens When Interest Rates Rise

In order to understand why raising interest rates could halt inflation, you have to understand economic principles. Don’t worry, no special degree is required and you won’t have to know any obscure Latin phrases.

The big thing you need to understand about the Fed raising interest rates is that it means borrowing money gets more expensive. You’ve probably already encountered this yourself if you’ve tried to buy a car or apply for a mortgage.

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So how Does Raising Interest Rates Help Inflation?

Coins on a scaleAs you’re probably aware, when things get more expensive, you tend to buy less. That’s exactly what the Fed is hoping will happen. They want to discourage people from spending, and if enough people start spending less, demand for products is going to go down.

The reason this is important is because one of the big causes of inflation is due to the imbalance between supply and demand. Thanks to the pandemic disrupting supply chains around the globe, there hasn’t been enough supply to meet demand. In accordance with one of the fundamental principles of economics, this has resulted in prices increasing on everything.

What the fed is trying to do is cause demand to drop so the demand no longer outstrips supply, or even have demand get lower than supply so prices might even drop a bit. Of course, if the Fed raises interest rates too much, they run the risk of causing people to spend so much less that they trigger a recession, but that’s another blog post.

What This Means for You

Hands with arrow-shaped plantSo what does this mean for everyday people? Unfortunately, it means that borrowing money has become more expensive, That means you’ll be paying more for all loans, including mortgages. The rising interest rates will also affect variable interest rate loans, like credit cards, so if you’ll be paying more interest on your outstanding credit card balance.

However, there is a way you can profit from rising interest rates. They don’t just apply to loans, mortgages and lines of credit—they also apply to savings and investment accounts, including money market accounts and certificates of deposit. In other words, this is a great time to start putting money into your savings.

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Take Advantage of Interest Rates With First Alliance Credit Union

When the Fed raises interest rates, they’re doing it to try to balance the scales of supply and demand and keep inflation in check. Unfortunately, this means that for most of us that borrowing money will get more expensive. However, this also means that interest rates on most savings and investment accounts will rise, so you might want to put more money into your savings.

If you want to turn the rising interest rates to your advantage, become a member of First Alliance Credit Union today. Put your money in a certificate of deposit or a traditional savings account, or even start an IRA to get a leg up on your retirement fund. You can keep track of how well your money is doing with our robust online banking platform to give you an overview of all your accounts.

We do our best to provide helpful information but we cannot guarantee the accuracy or completeness of the information presented in the article, under no circumstance does the information provided constitute legal advice. You are responsible for independently verifying the information if you intend to use it in any way. Additionally, the content is not intended to be reflective of First Alliance Credit Union’s products or services, for accurate and complete details about our product and service information you must speak to an advisor at First Alliance Credit Union.