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Interest Rates and New Yorkers


The Federal Reserve raised interest rates on March 15, 2017 – only the third time since the height of the financial crisis. So, what does this mean for New York City’s economy? First, let’s explore how interest rates work.

Whenever an entity loans money, they will charge an interest rate that incorporates the time value of money that is lost when loaning out that sum of money (a dollar today is always preferable to a dollar in the future, so an interest rate is charged to make loaning money cost-effective). Therefore, as interest rates decline, more people borrow and spend freely, raising inflation as demand for goods increases. The opposite remains true when interest rates increase.

The federal funds rate refers to one specific type of lending: the rate at which depository institutions (e.g., savings and commercial banks, credit unions, loan associations) lend their reserve balances to other depository institutions overnight. This type of lending allows banks to replenish their reserves to continue lending at the demanded rate. While this would only directly impact the 2,025 depository credit intermediation banks located within New York City, interest rate changes indirectly effect both financial institutions and consumers worldwide. The Federal Reserve does not directly manipulate the cost of borrowing; they rather adjust the supply of money available in the reserves of depository banks. Adding money to the reserves will lower interest rates, and reversely, removing money will increase interest rates.

It’s important to keep things in perspective: rates are still at an all-time low (see below). The Federal Reserve is expected to accelerate interest rate increases over the course of the next few years, with the Congressional Budget Office predicting rates at nearly 3% in 2021, warranting further analysis.[1]

As the base overnight lending rate changes, other interest rates adjust to the changes in cost and money supply. One way interest rate hikes will affect New Yorkers is the rising cost of purchasing a home. The cost of borrowing capital and mortgage prices will indirectly go up, thereby decreasing demand and possibly chipping away at the median home values. Below you can see how the thirty-year mortgage rate tracks closely with the federal funds interest rate.

As the federal funds rate goes up, the cost of purchasing a home will go up as well due to a higher mortgage interest rate. New Yorkers own homes at a much lower rate than across the United States (31% compared to 63% in the United States), which would make the interest rate hike more pronounced throughout the country; [2] however, New York City homeowners are more rent burdened than the rest of the population. There are currently 609,549 New York City residents with a mortgage, and nearly 50% of them are paying over 30% of their income each month on housing-related costs.[3] While New Yorkers have mortgages at a much lower rate than the rest of the country, those with mortgages are more likely to be rent burdened by payments on their mortgages.

Many will also be affected by higher interest rates on their student debt, as student debt burdens 16.8% of New York City residents. There were approximately 63,388 New York City residents enrolled in college or graduate school as of 2015 (38.3% of 18 to 24 year-olds in the city), and, according to a 2014 report put out by The Project on Student Debt, approximately 61% of New York State students have debt averaging at $27,822. This means that there is over a billion dollars in debt for New York City residents alone. While those locked in to set interest rates may not be further burdened, these data points show the sheer size of the student population in the city, and they indicate that students in the coming years may face higher costs of borrowing.

Analyzing historical data shows a strong correlation between the interest rate and the price of everyday goods As GDP goes up and aggregate consumer demand increases, the price of goods goes up as well, resulting in a marginal inflation. The monetary policy involved in interest rate changes can actually be used to manipulate inflation.

So, what does this all mean? In the words of Janet Yellen, the interest rate hikes send a “simple message” that the economy is doing well.[4]  We encourage you to continue to follow the moves of the Fed, as it is expected to continue to raise interest rates over the coming months and years.

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