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To help break it all down, Select spoke with economist Michael Gapen, managing director and head of U.S. economics research at Bank of America, about how increasing interest rates can help tamp down on inflation — and how doing so could result in a recession.
Today’s economy looks very different compared to last year’s, and concerns about inflation , market downturns and even a potential recession are weighing on the minds of many Americans. In these uncertain times, it can be difficult to make sense of such an influx of bad news: Why might there be a recession? Wasn’t inflation supposed to be transitory?
First off, inflation is defined as the rise in prices of goods and services in an economy. In July 2022, the inflation rate in the U.S., as measured by the Consumer Price Index, was 8.5%. That means the costs of goods rose by an average of 8.5% year-over-year. While not all goods and services were equally impacted by inflation, categories such as food and energy experienced the largest hikes.
The rise in prices across the board was caused by many different factors — the war in Ukraine led to a spike in energy prices, while supply chain shortages affected the prices of other goods, such as cars. In other words, high prices are being caused by having too little of a supply of goods and services and, at the same time, having too much of a demand for them.
That’s where the Federal Reserve System comes in — its primary function is to maintain a low inflation rate and unemployment rate in the U.S., which it does by controlling interest rates, or the federal funds rate. By increasing the federal funds rate, the Fed makes it more expensive for banks, and therefore consumers and businesses, to borrow money.
For consumers, higher interest rates mean it’s more expensive to buy big-ticket items that are typically purchased with credit, such as homes, automobiles, furniture and large appliances, says Gapen.
As a result of an interest rate hike, you may end up seeing a higher annual percentage rate, or APR, on your credit card or a higher annual percentage yield, or APY, on your savings account. That means that consumers who carry revolving debt on their credit card could see higher interest charges on their monthly statement. Those who currently have credit card debt may want to consider signing up for a card that offers a 0% APR introductory period on new purchases or balance transfers to help tide them over.
For example, the Wells Fargo Reflect® Card is a good no-annual-fee option that offers a 0% introductory APR for 18 months (after, 15.24% – 27.24% variable APR) starting from the date of your account opening, for purchases as well as balance transfers made within the first 120 days. There’s also an opportunity to extend it for up to three months as long as you continue to make on-time minimum payments.