With the Federal Reserve likely to raise interest rates on Wednesday, many Americans are puzzled over what this move means for jobs, their personal finances, and the day-to-day workings of the labor market around them.
This confusion is understandable. It's been a long time since the Fed raised interest rates. The last rate hike was way back in June 2006, when social media giant Twitter was still a twinkle in Jack Dorsey's eye and Barack Obama was a little-known senator from Illinois.
For many young workers today, interest rates have either been falling or have hovered near zero for their entire careers. If the Fed follows through with a widely anticipated rate increase on Wednesday, it will be the first wave of monetary policy tightening that many young Millennials have experienced.
How will a Fed interest rate rise affect the job market? As with most things in the macroeconomy, it's complicated. Interest rates only indirectly affect the labor market. And they do so with long time lags. Most research shows it takes 6 to 18 months for Fed policy changes to show up in the labor market.
Following the Money
Let's look at the three main ways workers may be affected by a Fed rate hike on Wednesday:
• Hiring May Slow: If a rate hike makes business loans more expensive or harder to come by, companies won't expand as quickly, slowing the pace of hiring.
• Drain on Your Wallet: If an interest rate rise makes mortgages and credit card debt more expensive, workers will feel the pain directly in their personal finances, which could mean a cutback on consumer spending.
• Stronger Dollar Means Pricier Exports (And a Drain on Exporting Jobs): Anyone working in business that rely on overseas customers--like manufacturing or tourism--may face hard times if a rate hike strengthens the dollar and makes American products more expensive to foreign buyers.
Let's take a closer look at each of these channels.
Investment and Jobs
First is the effect of a Fed rate hike on business investment. One of the main ways companies expand--particularly small and medium sized companies--is by borrowing from banks and investing that money in what economists call "capital": the machines, buildings and software that make workers more productive and help them do their work everyday. This is the way most growing companies expand, add to payrolls and tap into new markets.
When the Fed raises its benchmark "federal funds" rate, these new business loans get more expensive for companies--and again, particularly for small and medium sized companies. In turn, the interest payments on existing loans get more burdensome, cutting into companies' cash flow. That puts a damper on business borrowing, slowing down investment in capital, and possibly translating into fewer job openings for workers in coming months.
For some job seekers, this drop in business investment is particularly bad news. Workers at companies that produce investment goods like airplanes, machinery and semi trucks--such as Boeing, Caterpillar or Peterbilt--may face extra job risk as their livelihoods are directly tied to changes in business investment.
A less obvious impact of slower business investment is on wages. Investment in capital by companies is the main long-term driver of worker productivity and wages. Machines, software and buildings allow workers to produce more per hour on the job, enabling them to bargain for higher pay. If Fed tightening slows business investment, slower wage growth may be an unintended long-term side effect.
A second way Fed rate hike affects workers is through personal finances. Just as a rate rise makes business loans more expensive, consumers' personal loans get more expensive as well. This has the potential to slow consumer spending, which today makes up about 68 percent of the economy, pulling the overall economy into a slowdown in response.
Mortgages are the biggest consumer loan facing most Americans. Most mortgages today are fixed-rate and won't be affected by a Fed rate hike. But new borrowers will face higher rates and heavier mortgage payments, putting a drag on personal finances.
Consumer credit card debt will also get pricier if the Fed raises rates on Wednesday. Most credit card annual percentage rates (APRs) move in lockstep with Fed interest rates. Although the Fed typically moves in tiny 0.25 percent increments, credit card spending is surprisingly responsive to interest rates. Research shows a 1 percent rise in APRs cuts consumer debt spending by 1.3 percent--a potentially significant jolt to consumer spending.
The final way a Fed rate hike will affect workers is through currency markets. As the Fed raises rates, the U.S. becomes a more attractive place for investors around the world--particularly in Europe where many interest rates are negative. As the dollar strengthens, U.S. products and services become more expensive to foreign buyers. That hurts anyone working at companies that export. And American companies today export a lot more than physical goods, which means manufacturing workers won't be the only ones affected. Workers who export services like consulting and tourism would be affected as well.
How much will exports be affected by a Fed rate hike? One back-of-the-envelope estimate by economist Menzie Chinn suggests a 0.25 percent rate rise could boost the value of the dollar about 3 percent. That amounts to a 3 percent price hike facing overseas customers of American goods--not huge, but certainly noticeable.
In the past, slowing exports mostly affected manufacturing and goods-producing companies. But today, high-skilled services like consulting and finance make up one-third of U.S. exports. If a Fed rate hike boosts the already strong U.S. dollar, sluggish sales and job growth could be around the corner for a large number of companies selling goods and services around the globe.
Into the Unknown
Despite volumes of research in macroeconomics, the exact links between Fed policy and the labor market are still not well understood. In theory, economists know how a change in interest rates should affect jobs and wages. But in practice, the empirical evidence is surprisingly mixed, due partly to poor macroeconomic data. In many ways, as the Fed begins "liftoff" on interest rates we're stepping into the unknown--something economists will be watching closely in coming months.
This post originally published on Glassdoor Economic Research.