Interest rates have been around since the dawn of civilization. In fact, they can be traced all the way back to 3,000 BC. It didn’t take long for people to realize that interest rates were a necessary part of the borrowing and lending equation.
Without interest rates, lenders couldn’t make money through their services, and there would be no rewards for assuming all of the risk. They may or may not get paid back, but they certainly wouldn’t make money on the transaction. That would make it impossible for borrowers to find lenders.
Interest rates gave borrowers some skin in the game and made the process more attractive to lenders.
These rates have changed a lot over the years. Back in the very early days, it wasn’t uncommon to see rates around 20 percent or higher. Today, interest rates that high would cause a panic.
Look at the interest rates of the past and today to get a better idea of the impact they have on the economy.
How the Government Has Manipulated Interest Rates in the Past
The Federal Reserve sets the benchmark interest rate for the United States. It’s known as the fed funds rate, and it’s the rate banks charge other banks to lend Federal Reserve funds to each other overnight.
The sweet spot for this rate sits anywhere between 2 and 5 percent, but it has to be manipulated from time to time. It might go lower to stimulate economic growth or higher to curb inflation. In both cases, it has an impact on banks, the economy, and average consumer borrowers.
The 1920s is the perfect example of the power of interest rates. Stock prices kept going up, but the Federal Reserve didn’t want to raise the rates. Rampant bank lending caused prices to go up even more.
The Federal Reserve finally stepped in, but it was too late. The damage was done, and it set off a series of events that caused the stock bubble burst. That, of course, led to the Great Depression.
Interest rates also took center stage in the 1970s due to inflation. This time period was known as the Great Inflation.
The inflation was caused by a variety of issues, but the Nixon Administration played a significant role in the Great Inflation. America was reeling from a mild recession during his first term, and he wanted to gain support in order to win reelection. He decided to do away with the gold standard as a way to stimulate the economy.
The Federal Reserve had raised interest rates as a way to defend the gold standard. By doing away with the gold standard and applying pressure to lower the interest rates, Nixon hoped to create a system of cheap money.
While money got cheaper, inflation started soaring. Inflation hit double digits, and the Federal Reserve raised the rates to combat it. The rate made it up to 20 percent in 1979.
Interest rates went in the opposite direction in 2008 during the Great Recession when the Fed slashed interest to 0.25 percent. This caused several banks to lower the prime lending rate in an effort to stimulate the economy.
These are only a couple of recent examples of where the government has manipulated interest rates in an effort to control the economy.
Interest Rates Today
Lowering the interest rates during the economic recession of the late 2000s seemed to work. The economy is on the mend, and the Federal Reserve is actually starting to raise rates once again. However, it is taking a cautious approach.
The Federal Reserve made three hikes from December of 2016 to June of 2017, and the rate currently sits at 1.25 percent. It is expected to go up to 2 percent in 2018 and then another percentage the following year.
This is a sign the dollar is strengthening, the job outlook is strong, and the economy is heading in the right direction. It is also good news for banks. They can take their prime interest rates up a tick or two and earn more money from consumers. At the same time, rates remain low enough to stimulate borrowing.
Keep an Eye on the Rates
Interest rates aren’t just something people have to pay when they take out a loan. They are a good indication of the economy’s health. If the rates are too high or too low, consumers should check for reasons why this might be the case. The dollar might be weakening, or a major political change may have occurred.
The Federal Reserve tries to stay out in front of the issues by manipulating the interest rate. Understanding this could be useful in getting the most out of borrowing from lenders and reducing the overall cost of borrowing.