Guess what? Interest rates can go up. The Federal Reserve believes the economy is in good shape to begin weaning it off the massive stimulus it has pumped into the system. Is that good news? The answer is of course yes.

Is the economy really well positioned? Yes it is. The growth is strong. In the spring and summer, the percentage increase was the second largest on record. Even better, the level of activity is now higher than it was at the time of the pandemic.

In addition, the country’s unemployment rate has plummeted, falling nearly 10 percentage points since the peak of the pandemic in April 2020. Employment growth is robust and there are more vacancies than the number of unemployed.

In other words, the economy is back. And that’s important because the Fed has a dual mandate: maximum sustainable employment and stable prices.

The maximum sustainable share of employment seems in sight, but stable prices? I am not sure.

Strong growth paired with high inflation illustrate the tensions in the Fed’s mandate: Sometimes a rapidly expanding economy can trigger price increases. When you add a global supply chain breakdown to robust economic activity, you have real consumer price problems. Inflation is well above the Fed’s target of an average of 2%.

So what does a good central bank do when the economy no longer needs its help and inflation is showing its ugly head? Increase prices.

And that’s the path the Fed has taken.

When the pandemic broke out and the economy collapsed, the Fed used every tool at its disposal. It lowered the interest rate it controlled, the federal funds rate, to near zero, and all other rates followed suit.

The Fed also opened the liquidity tap and bought massive amounts of securities. It added more than $ 4 trillion to its balance sheet and ultimately to the economy. One reason for the rise in the stock market is the enormous inflow of funds not only into the economy, but also into the financial markets.

With the recovery well established, it was time to reconsider the policy. At the September meeting of the Federal Reserve’s FOMC, the Fed’s rate-fixing group, it was announced that “if progress broadly continues as expected, the committee believes that a slowdown in the pace of purchases is needed of assets could soon be justified ”. . “

In other words, the Fed is starting to get out of the business promotion business.

What does this mean for the average person? It starts with interest rates and extends to the general economy and markets.

The purpose of buying securities was to lower interest rates on the full spectrum of assets, from very short-term such as three-month Treasury bills to long-term such as 30-year fixed-rate mortgages. The Fed has done a fantastic job and rates are still at or near historic lows.

By reducing its asset purchases and most likely selling them later, the Fed will end downward pressure on interest rates. Interest rates are likely to rise.

The decline in asset purchases isn’t the only reason interest rates should rise. At its last FOMC meeting, the Fed signaled that it could start raising the key rate as early as the end of next year.

When the Fed signals an imminent change of course, the markets react. If the economy remains solid, as expected, and inflation continues to rise in 2022, the Fed is very likely to hike rates and markets will follow suit.

Are Rising Interest Rates Bad? It depends on why they are gaining weight.

The Fed’s actions to start the rate hike process are based on the fact that the economy is able to survive on its own. Massive incentives from the Fed and the federal government have lifted us out of the recession and supported the robust growth we’ve seen for more than a year. This help is no longer needed, so what the Fed is doing is a positive sign.

However, rising interest rates mean consumer and business borrowing costs are increasing. Payments on new mortgages, auto loans, home loans, and investment loans all go up when interest rates go up. And that has a dampening effect on economic growth. But that’s not bad for the Fed. Since inflation is hot, it wants to slow growth so that price increases slow down.

The stock markets are also potentially affected. Part of the liquidity flowed out on the stock markets and supported the rapid rise in prices. This support will wear off and could be reversed.

In addition, higher interest rates affect stock prices. The price of a stock depends on the value of the return the investor receives over time. This stream of returns has to be valued in today’s dollars, using interest rates to determine what is known as the present value. The higher the interest rates, the lower the value of future income and the lower the current price of an asset.

This means that the rate hike can spill over into the stock markets. I’m not saying the markets are going to fall. You don’t have to if earnings remain strong. But it does suggest a potentially slower rise in stock prices.

There are higher rates. You have to, as the current values ​​don’t make sense. Think about it: if you buy a 10-year government bond that yields 1.5%, but inflation averages the Fed’s 2% target over those 10 years, you lose purchasing power every year.

Yes, higher fees create costs for consumers and businesses. But they also send the message that the economy is back. We should recognize that as a good thing.

Joel L. Naroff is President and Founder of Naroff Economics, a strategic economic consultancy in Bucks County.