Changes in the interest rate affect almost every business and consumer activity. Some examples of interest-sensitive activities are:

Real estate construction
Refinancing of residential property
Buying of residential property
Investing in residential and commercial real estate
Initial and secondary public offerings of real estate investments
Initial and secondary public offerings of real estate companies
Employment
Prime rate and subsequent corporate borrowing
Consumer borrowing
Stock market prices
Bond prices

Why did interest rates move to their present level, and where are they going? Interest rates increase or decrease through the influence of the Fed. Those factors carrying the most influence with the Fed’s decision making process are the growth or decline of government debt, employment or unemployment statistics, the economy, and inflation or deflation.

Predicting the direction of future interest rates requires two points of reference. The two points of reference I will use are 1981 (25 years ago) and today.

1981

I chose 1981 because the Fed’s discount rate was at an all-time high: 14%. The rate of inflation was 10.3%, which was the third year in a row it was a double-digit figure. The last time our country experienced consecutive years of double-digit inflation was during the 1917 to 1920 period. The unemployment rate was 7.6% and climbing. The national debt rose 11% from the prior year. The Fed kept increasing the discount rate until it (and probably Reagan’s tax reductions) brought inflation and the economy into line.

Today

The war on terrorism is a major contributor to the recent 11% jump in our federal deficit. Unfortunately, this new type of war is difficult to bring to a finality. The rate of inflation jumped to 4.2%, albeit still a low number, or the beginning of a trend. Interest rates are off their lows, but still low enough to fuel a healthy economy. The strongest (and weakest) part of the Fed’s equation is the unemployment rate at 4.5%. Full employment may be good for the social fabric of our
country, but the historic tendency of full employment is to stimulate inflation.

Conclusion

When all is said and done, in spite of a handful of dreamers who believe that further interest rate increases are unlikely, the probabilities are that’s not going to happen. There are more reasons and pressure for higher interest rates than there are for holding the status quo at current levels. To soften the future blow of higher rates, rate changes will probably be stretched out over time and mitigated by the announcements of good news and economic hope with each increase.

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