How interest rates and tariffs affect the economy
Both interest rates and tariffs can have a notable impact on the U.S. economy.
Interest rates dictate how much it costs consumers to borrow money. They also determine how much it costs companies to borrow money to finance operations.
When interest rates are higher, consumers tend to spend less. It's for this reason that the Federal Reserve tends to raise interest rates during periods of higher-than-average inflation.
Inflation commonly comes as the result of a mismatch between supply and demand. When there's not enough supply to meet demand, prices tend to rise.
By raising interest rates, the Fed can discourage consumers from spending. That, in turn, narrows the gap between supply and demand, causing prices to come down.
Tariffs, meanwhile, can lead to higher costs for imported goods. If it costs more for U.S. supermarkets and retailers to source the products they sell, those higher costs are generally going to be passed onto consumers, resulting in higher prices.
Of course, the hope is that U.S. companies will source more products domestically in light of tariffs. But that won't necessarily result in lower prices.
Quite the contrary — domestic goods are commonly more expensive to produce, which could lead to higher prices. In fact, the whole reason the U.S. is so heavily dependent on foreign trade partners is that it's historically been more economical to source certain products than produce them domestically.
In response to the expected impact of tariffs, the Fed raised its 2025 inflation forecast to 2.8% in mid-March.
The reason Trump is pressuring the Fed to lower its benchmark interest rate is to make borrowing less expensive for consumers. Lower borrowing rates could potentially offset some of the higher costs that may result from tariffs.
But lower borrowing rates could also fuel inflation by encouraging more spending. So, it’s easy to see why the Fed isn’t in a rush to go that route.
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Learn moreHow to adjust your finances in today's economy
It's hard to know what actions the Fed will take in the coming months, and it's hard to predict the exact impact of tariffs on the average consumer's wallet. But, there are some steps you can take to protect your personal finances given current circumstances.
First, know that until interest rates come down, borrowing is going to be more expensive. So, 2025 may not be the best time to sign a new loan or refinance an existing one. You may instead want to focus on boosting your credit score so that if rates come down next year, you'll be in a strong position to borrow.
On the other hand, you should know that while elevated interest rates are bad news for borrowers, they're great news for savers. Now's a good time to put extra money into a high-yield savings account. You can also open a certificate of deposit (CD) if you have cash on hand you don't expect to need for a period of time, which guarantees you the same interest rate until its maturity date.
Given that there's pressure on the Fed to cut rates, a CD could be a good bet. If interest rates fall, savings accounts are apt to start paying less. But if you lock in a CD at a given rate, your bank has to honor that rate.
You may also want to boost your emergency fund given that economic conditions could potentially fuel a recession or cause stock market volatility.
On March 13, the stock market entered correction territory for the first time in more than a year (meaning it fell at least 10% from a recent high, but less than 20%). Tariff policies, once implemented, could drive stock values down even more. So, now’s a good time to rebalance your portfolio as needed or potentially cash out some remaining gains if your emergency fund needs a boost.
A recent U.S. News & World Report survey found that 42% of Americans have no emergency fund. While J.P. Morgan's chief economist puts the chance of a U.S. recession at 40% this year.
A recession could lead to widespread layoffs, which is why it’s important to have a solid emergency fund — one with at least three months of living expenses. A fully loaded emergency fund could make it easier to leave your stock portfolio alone in the event of market meltdown, sparing you from locking in losses due to needing cash.
Of course, no one has a crystal ball, so it’s hard to know how things will shake out economically in the coming months. But, it’s best to prepare as best as you can by stockpiling some cash and being careful about taking on new debt. You should also make sure your investment portfolio is well diversified, to withstand potential turbulence.
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