Money Rehab with Nicole Lapin - Interest Rates Are Changing. Here's How to Make the Most of It.

Episode Date: June 13, 2022

Nicole shares everything you need to know about how interest rates are changing, what that has to do with what you’re paying at the grocery store, and how you should adapt.  

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Well, it doesn't. Charge for wasting our time. I will take a check. Like an old school check. You recognize her from anchoring on CNN, CNBC, and Bloomberg. The only financial expert you don't need a dictionary to understand. Nicole Lappin. We are living in some strange financial times.

And as a result, a lot of the money-adjacent topics currently in the headlines might sound like gibberish. You may think you need a PhD just to turn on the financial news, but you don't. Seriously. Money stuff isn't that complicated. It just sounds complicated because of the jargony way Wall Street bros talk about it. One of the most jargony topics I'm seeing in the news right now is the coverage on interest rates. In this episode, I'm going to share everything you need to know about how interest rates are changing, what that has to do with what you're paying at the grocery store, and how you should adapt. Interest rates are changing in response to inflation. So in order to dig into interest rates, I want to make sure we're on the

same page about inflation. If you've been listening for a while, you've heard my inflation analogy before, but if you're new here, let me explain. Tracking inflation is similar to making a cup of coffee. The coffee grounds in the filter is the U.S. dollar. Inflation is the amount of water that runs through the filter. Your bank account is the cup of coffee. If there's less water, your coffee is going to be stronger. If there's more water, you're going to need more of the coffee grounds in order to achieve the same strong cup of joe. If you don't get more coffee grounds to counteract the increased amount of water, that's when you're going to get watered-down coffee. I certainly don't like weak coffee,

but what I like even less is watered-down net worth. And watered-down net worth is, unfortunately, what's happening now. Inflation has skyrocketed, and it's clocked in at almost 9%, and we're feeling the elevation everywhere, especially in grocery stores and gas stations. Last year, Treasury Secretary Janet Yellen said she didn't think that inflation was going to be a problem. Last week, she admitted she was wrong. And you know it's bad when someone in Washington admits that they're wrong. So when the U.S. needs to lower inflation, the Federal Reserve steps in. The Federal Reserve, or just the Fed, is the government branch that acts as the central bank of the United States. The Fed works with commercial

banks like Jason, Wells Fargo, and all the heavy hitters to adjust the amount of money in supply and interest rates, and therefore inflation. I'm going to give you the golden rule of interest rates first and then dig into why that rule exists. So bottom line is, don't worry if this doesn't click with you right away. I'm going to explain it at length, but I want you to be able to keep this intel in the back of your mind as we're digging in. Here's the rule. To encourage spending, the Fed wants to make it easier to borrow money.

And so the Fed lowers interest rates. To slow inflation, the Fed wants to make it harder to borrow money. And so the Fed raises interest rates. Okay, let's unpack this. The link between borrowing money and inflation is one we have probably heard before, but maybe haven't actually synthesized it. I remember one day when I finally faced my inflation blind spot and thought, wait a minute, why is it bad for the economy when money is easy to borrow? That doesn't make sense. More borrowing means more spending, and more spending should be a good thing, right? Well, it all comes back to supply and demand.

Let's not worry about the demand for money, because we all know that money is always in high demand, and just think about the supply of money. For our purposes here, supply does not just mean how much money is being printed by the mint, but how much money is in circulation, or rather in the hands of people, and more importantly, trading hands between people. During tough economic times, like a pandemic, when people anticipate that money will be harder to come by, they're going to want to keep what they have. However, that's problematic because when people don't spend money, the economy grinds to a halt. Simply put, in recessionary times when people have less spending power, the economy

really hurts. People don't buy their lattes, they don't go out to eat, they don't go back to school shopping. That means the owners of their local cafe, restaurant, and office supply store don't have any money coming in and their business suffers. And when their business suffers, they lay off people and the web of the economy starts to unravel. The government, to keep the economy running, will want to boost spending power. In order to do that, the government can do things like issue stimulus checks. But they can also intervene with the money supply and interest rates so that it's easier for people to borrow money. The government's rationale is this. If the economy is slowing down, let's make it easier for people to borrow money so they have

more money to spend. But it's not only individuals that the Fed wants borrowing money. It's also businesses. Remember those cafes, restaurants, and office supply stores who needed to lay off employees? If businesses can easily borrow money, they could probably keep their employees happy and more generally keep the lights on. So far, so good, right? It seems like this solution of infusing the economy with money helps keep people employed and drinking their lattes. A win in my book. And lowering interest rates and encouraging spending is what the Fed did at the beginning of the pandemic. However, when the government pumps money into the economy, it's often the case that the money supply is growing faster than the supply of domestic goods.

This can result in two different kinds of inflation, demand-pull inflation and cost-push inflation. Both of these classifications come from our dear friend John Keynes, a famous economist in the 1900s and a money rehab icon. Demand-pull inflation describes the experience of Americans having more money to spend than things they can buy. Therefore, high demand pulls the prices up. For example, if interest rates on mortgages go down, that means that all of a sudden potential homebuyers can now anticipate spending less on the cost of housing, which means that they have more money to play with.

If that's the case, and then a bajillion people are swarming housing tours and looking to nest their faces off, housing prices can rise because people are willing to pay higher prices. In cost push inflation, costs are pushed up because of higher prices on raw materials. With the supply chain shortages, you can take your pick on examples of cost-push inflation. Semiconductor shortages means more expensive TV sets. Labor shortages means more expensive food in grocery stores. There's an example basically everywhere you look. Going back to our coffee analogy, though, we can say that during the pandemic, the Fed added more water and more coffee grounds to the coffee maker in hopes that we would have more coffee in our cups and not feel like we have to savor every last drop. But the issue is the Fed has been adding water faster than they're adding coffee grounds,

and so we end up with weaker coffee. Now the Fed needs to pull back what they did to encourage spending during the pandemic. This is where interest rates comes in. The Fed is raising interest rates so that it's harder to borrow money. Raising interest rates is like turning down the faucet that you're using to fill your coffee maker. The hope is that less water means stronger coffee, or in other words, will make your money worth more and curb inflation. Now you may be thinking, wait a minute, so you're saying that the Fed is turning the faucet down and trying to slow the economy? Didn't we just say that that's a bad thing and leads to recessionary times? Yes, you're exactly right.

Going back to our trusty analogy, the concern here would be that the Fed turns the faucet down too much or, in other words, makes it too hard to borrow money, which in turn lowers spending and ultimately brings us back to the economic issues we were seeing at the beginning of the pandemic. But the Fed is trying to avoid that and shoot for what they call a soft landing, which the New York Times describes as a state of Goldilocks perfection, in which growth is neither too fast nor too slow and prices are just right. The Fed has signaled that by the end of the year, interest rates will be around 2.5%. And the Fed is hoping that 2.5% is that perfect Goldilocks rate. Higher interest rates are good for some people and bad for others.

If you have debt or you're planning on taking on debt, that includes credit card debt, a car loan, a mortgage, a business loan, then your interest is going to be higher. That means you'll end up spending more to pay off your debt in the long run, which we do not like. If you're a saver, though, you're going to get more interest at the bank, and that we do like. In anticipation of more hikes, it's a good time to, one, pay down debt. Two, if you've had an adjustable rate mortgage and you've had a certain fixed rate that's nearing an end, refinance. Number three, try to lock in a rate if you're in the market for a car this year but aren't quite ready. For today's tip, you can take straight to the bank, despite the rate hikes, interest rates are still historically

low. Back in 1980, interest rates were 21%. So don't let these headlines make you panic. Yes, recessions are scary. But here's the thing. The U.S. has never not recovered from a single recession or depression in U.S. history. So while there are a lot of sucky things, if you really lean into financial literacy right now, this is the time when huge fortunes can be made. Money Rehab is a production of iHeartRadio. I'm your host, Nicole Lappin. Our producers are Morgan Lavoie and Mike Coscarelli. Executive producers are Nikki Etor and Will Pearson. Our mascots are Penny and Mimsy. Huge thanks to OG Money Rehab team Michelle Lanz for her development work, Catherine Law for her production and writing

magic, and Brandon Dickert for his editing, engineering, and sound design. And as always, thanks to you for finally investing in yourself so that you can get it together and get it all.