The Fed's New Tolerance for Inflation Could Be Trouble for Consumers

Today's FOMC meeting statement kept the fed interest rate near zero due to the recession and confirmed that fed rate hikes will be slow in coming even if inflation rises.
By Richard Barrington

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The big news from today's Federal Open Market Committee (FOMC) meeting statement was not about where the Federal Reserve interest rate is today, but about where it is likely to be in the months to come.

The Fed reiterated a major policy shift by saying that interest rates would remain at historically low levels for the foreseeable future, even if inflation rises above the Fed's 2% long-term target.

This greater tolerance for inflation could have a major impact on consumer finances.

Fed Interest Rate Unchanged

The FOMC left the target for the federal funds rate at a range of between 0.0% and 0.25%. This was no surprise. It is essentially as low as the fed funds rate has ever been, even in the aftermath of The Great Recession.

The Fed also reiterated an August 27, 2020 revision to its Statement on Longer-Run Goals and Monetary Policy. This said that, while in the past the Fed wanted to maintain an inflation target of 2%, it would now be willing to allow inflation to rise above that target for a while since it has been consistently below that target in recent years.

Recession and COVID-19: What the Fed Said

The Fed noted that, although economic conditions have improved a little in recent months, economic activity and employment remain well below where they were at the beginning of the year.

The Fed acknowledged that the future of the economy depends greatly on the course of the COVID-19 pandemic. That health crisis weighs heavily on the economy in the near-term and represents a significant risk in the medium-term future.

This does raise the question of how much federal interest rate policy, including the FOMC's recent decision of increased tolerance for inflation, can hope to accomplish. Low interest rates can't do much to stimulate economic activity when millions of people are unable to work or spend money because of the pandemic.

FOMC Meeting Impact: What Consumers Need to Know

FOMC meetings concern more than just economists and professional investors. Fed interest rate hikes and cuts impact ordinary household finances in a variety of ways.

The following are some questions and answers concerning how current FOMC policies may affect your household finances.

Is this a good time to borrow?

Interest rates are already very low. With the Fed now stating that it's willing to tolerate more inflation before it raises rates, it could make interest rates even more attractive for borrowers.

Important caveat:

There is one important catch, however. Rates are very low right now in part because of the pandemic and the recession. Those conditions have already cost millions of Americans their jobs and could threaten the jobs of millions more.

So before you borrow, take a hard look at how secure your job is in today's world. If current conditions threaten your job security, you may want to hold off on borrowing.

However, this could be a good time to refinance debt you already have, if it allows you to lower your interest rate.

What can you do about your savings losing ground to inflation?

The Fed's willingness to keep interest rates low even if inflation rises is bad news for savers.

Savings account interest rates had been below the rate of inflation for most of the time since the Great Recession. Now, with fed rate hikes less likely to come even if inflation rises, savers face losing even more ground to rising prices.

How to fight against inflation impacting your savings:

However, people with savings accounts, money market accounts and certificates of deposit (CDs) can fight back by actively shopping for higher rates. Studies by have consistently shown large differences between the highest bank rates and the average.

That means most bank customers still have an opportunity to raise their rates, even in a falling rate environment. All they have to do is shop for a better rate instead of settling for average.

When will the next fed rate hike come?

This depends on progress in the economy and on what happens with inflation. The Fed has stated it is now willing to let inflation rise above 2% long enough to bring the average rate of inflation up above 2%.

Just as an example, since inflation has averaged 1.44% for the past dozen years, inflation could run at an annual rate of 3% for six years and nine months before the overall rate of inflation reached an annual average of 2%.

In theory, this means it could take nearly seven years of 3% annual inflation before the Fed would raise rates again.

What does this mean for your retirement fund?

A greater tolerance for inflation could mean you need to save more for retirement because it could cause the cost of living to rise at a faster rate.

At the same time, a longer-term commitment to low interest rates means that retirement savings may produce less income. This could also require you to save more in order to meet expenses in the future.

Is this a good time to invest in stocks?

Low interest rates have helped fuel a stock market rally in recent months, even as the economy has slipped into recession.

This means stock prices have risen faster than earnings, resulting in higher price-to-earnings (P/E) ratios. This could result in lower long-term returns going forward.

Thus, low interest rates have been good for stocks in the short term, but may have made them riskier for the long-term.

Previous Federal Reserve Board Updates articles:

FOMC Date2020 FOMC Meeting Update Articles
07/30/2020Fed Rate Unchanged: What Consumers Should Do
06/11/2020With No Rate Cut from the Fed, Now It's Your Move
04/30/2020How Will the Latest Fed Meeting Affect Consumers?
03/19/2020Fed Moves Show Urgency of Coronavirus Response
01/30/2020Fed Rate Decision Means Consumers Have a Choice

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