Interest Rates and Economy
When interest rates fall, the cost of short term borrowing goes down which encourages consumers and businesses to spend, this will in turn stimulate the economy. The opposite will occur if the rates rise. The Fed regularly adjusts the rates with the goal to keep the economy growing at a healthy pace without too little or too much inflation. However, the Fed may not always be successful, for example, the rates were near zero in 2008 but the financial crisis still happened.
Interest Rates and Inflation
If there is any sign of inflation, interest rates (and bond yields) will tend to rise. If the Fed believes the economy is overheating, it will raise the interest rates therefore slow down the economic activities and consequently keep inflation in check. The Fed has a target inflation rate of 2% which is about where rate is today.
In next blog post, we will discuss how does interest rate affect stock market and what should be your investment strategy if the rates are about to rise.