Looking Back on America’s Most Dire Inflation Periods

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If you’ve been watching the news, you may have noticed that interest rates have been on the rise. And whether you’re earning more interest from your bank or paying more interest to lenders or credit card companies, there’s a good chance that the situation has something to do with the federal funds rate.

Consumers in the United States have seen the federal funds rate rise from close to zero a year ago to a target range of 4.5-4.75%. This hike is the quickest increase the country has experienced in around four decades, and the federal funds rate itself is the highest it’s been in over 15 years.

Here’s what you need to know about the federal funds rate, why it was created, and the reasons it has increased so much in recent months. You’ll also learn about other times the Federal Reserve has hiked the federal funds rate in the past and how those situations compare to the current economic climate.

What Is the Federal Funds Rate?

The federal funds rate is a target interest rate range that banks in the United States charge one another to borrow money when lending excess reserves overnight. This interest rate isn’t the same as what consumers pay to borrow money. However, the federal funds rate does influence the interest rate lenders charge for consumer debt.

The federal funds rate can also impact the annual percentage yields (APYs) financial institutions pay out to their customers. That may impact the money you earn on deposit accounts, such as checking accounts, savings accounts, money market accounts, certificates of deposit, etc.

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The Federal Open Market Committee (FOMC) is the group within the Federal Reserve (aka the Fed) that’s responsible for setting the federal funds rate. The FOMC meets eight times a year to set the target rate and reserve requirements. 

The next time the FOMC meets will be March 21-22, 2023. When the FOMC meets, its members decide between one of three courses of action: lower the federal funds rate, increase it, or maintain the current target rate.

Why Has the Federal Funds Rate Increased So Much In Recent Months?

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By influencing interest rates, the goal of the Federal Reserve is to maintain financial stability in the U.S. economy. During economic slowdowns (such as a housing crisis or pandemic), the Fed may lower interest rates to combat unemployment and encourage spending and investment.

In February 2023, the FOMC announced its eighth consecutive rate hike by the central bank. To understand why the Fed has increased the federal funds rate so much (and so rapidly) over the past year, it’s helpful to take a closer look at what has been going on in the U.S. economy since 2020.

• During the coronavirus pandemic, the FOMC called for an emergency rate cut in March 2020 that slashed the federal funds rate to 0.00-0.25%. 
• The federal funds rate proceeded to sit at 0% for over a year throughout the pandemic. For reference, the consumer price index (a measure of inflation) was 1.3% in 2020.
• In 2021, inflation began to climb sharply to 7.1%. 
• In March 2022, the Fed announced a 0.25% increase in the federal funds rate to curb rising inflation throughout the country. The rate bump represented the first of its kind since 2018. 
• The United States experienced peak inflation of 9.1% in June 2022 — a 40-year high and the largest annual increase since 1981. 
• Inflation-related pressures have slowed but remain a painful issue for Americans. Despite persistent increases of the federal funds rate, inflation remained at 6.4% in January 2023.

The Fed likes to see the annual inflation rate hover around 2%. When inflation exceeds this rate, rapidly rising prices can create serious financial problems for households and businesses throughout the country.

By raising interest rates, the Fed aims to slow consumer and business spending (thus curbing inflation as a side effect). When credit card interest rates rise, for example, consumers may be less likely to make purchases they cannot afford to pay off since higher interest rates will increase their monthly payments and overall interest costs. As consumer demand for goods and services goes down, prices should follow.

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Other Times the Federal Funds Rate Has Increased

The Fed has increased the federal funds rate previously as a means to bring inflation under control. Sometimes, those efforts have resulted in recessions that curbed inflation but also stymied economic growth and triggered higher unemployment rates.

One of the most well-known periods wherein the Federal Reserve hiked interest rates took place in the 1970s and 1980s. Here are some of the highlights to explain what happened.

1970s and 1980s Fed Interest Rate History

In the 70s and 80s, the Fed was facing rampant inflation that eventually peaked at 14.8%. Prices on goods and services soared throughout the United States, and Americans were even facing fuel rationing at the gas pump at certain times.

Starting in 1972, the FOMC voted to increase the fed funds rate by a total of almost 10 percentage points to bring the situation under control. By 1980, the federal funds rate was 19-20%—an all-time high.

However, the interest rate changes of the 70s and 80s weren’t the gradual ones Americans have experienced in recent months. Under the leadership of then-Chairman Paul Volcker, the Fed raised and lowered the federal funds rate by as much as 2% at a time.

In response to a sky-high federal funds rate, interest rates on mortgages rose as high as 18% at one point. That rate is as high as what some consumers are able to qualify for on low-interest credit card offers today.

Eventually, prices came back under control. As a side effect of the aggressive fed funds rate bumps, however, unemployment climbed to 10%, and the economy underwent two recessions.

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What’s Next for the Federal Funds Rate?

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No one can be sure what the future holds in terms of the federal funds rate, inflation, and the U.S. economy as a whole. In light of the stubborn inflation numbers Americans are still facing, some financial experts (including Goldman Sachs and Bank of America) anticipate several more interest rate increases by the Fed before the end of the year.

What do additional increases in the federal funds rate mean for you when (and if) they happen? First, if you have revolving outstanding balances on your credit card accounts, it’s important to pay down your credit card debt.

When interest rates are on the rise, it can also be a great time to research and see if you could be earning more interest on your savings. There are plenty of low-risk strategies you can use to make your money work for you, whether you’re working to put away cash for emergencies, save a down payment for a home, or reach some other financial goal.