How Will the Fed’s Interest Rate Cut Affect Consumers?

We have long been following the actions of the Federal Reserve Board through our weekly series, Fed Watch. During the recent Fed meeting that was scheduled for September 17 and 18, the Fed lowered interest rates with a 50-basis-point cut. With this highly-anticipated cut finally coming to fruition, just what kind of impact will it have on consumers?

Positives of Lower Rates for Consumers

Lower interest rates make it cheaper to borrow. This is a good thing for prospective homebuyers, car buyers, or those carrying consumer debt such as credit card debt. Lower interest on new loans, variable rate loans, and some refinances frees up money that can be saved for the future or spent elsewhere.

Overall, lower interest rates are generally positive for most consumers; however, not all consumers will be impacted in the same way, and lower rates may contribute to some future problems.

Potential Negatives of Lower Rates for Consumers

Lower interest rates can lead to higher inflation. When inflation is higher, purchasing power is diminished. The impact is particularly significant for those with lower incomes or fixed incomes.

While some people are willing to take out loans – depending on their needs – regardless of interest rates, lower rates will generally attract more borrowers. The greater number of borrowers could put upward pressure on prices due to increased demand. However, this pressure will not impact consumers right away; it typically takes time to play out.

Recent Example of Lower Interest Rates Driving Up Prices

We saw a situation like this play out in the early 2020s, when interest rates dropped to record lows. On the surface, it seemed like a big win for consumers, as they could refinance their existing debt and lock in new, lower interest rates. However, because the affordable borrowing fueled more buying, prices were driven higher.

Interest rates were a significant contributing factor to the broad-based inflation of the early 2020s, especially in markets where purchases are typically financed, but there were other contributors as well, including stimulus checks and supply-side limitations. Interest rates are not the whole picture, but they are quite influential.

Early in the decade, prospective homebuyers were able to get incredibly low mortgage rates; however, the increased competition fueled bidding wars for new homes. If you were one of those who were lucky enough to lock in a low mortgage rate for a new home early on, you got a good deal. But just a few months later, prices were ramping up. By the time the Federal Reserve began raising rates again two years later, the US Housing Price Index had already risen 35%, with even higher increases in some locales.

With the Federal Reserve Board lowering interest in September, it will be interesting to see if consumers jump at the lowered rates right out of the gate, or if more decide to wait for further rate cuts.

To stay up to date on the latest Fed activity and economic insights, keep following ITR Economics.