Fear of Soaring

Older people, who have lived through inflationary periods, may expect prices to go up over time. But many young adults have been raised on ever-falling prices for clothes, cars and computers, and thus may be more upset by rising prices. However, it remains to be seen whether they will be less willing to pay them.

Similarly, families that had been planning to buy a house may react differently to rising mortgage rates. An older family may think rates below 7 percent are still pretty good compared with the past; a younger family may be disappointed because their peers snapped up home loans at rates below 6 percent.

Moreover, because most Americans' biggest store of wealth is their house, an older family with a valuable home and a low, fixed-rate mortgage may be in good financial shape to weather the coming changes. By contrast, a young renter with lots of credit card debt might have more trouble keeping up with rising expenses as the adjustable-rate interest payments on that debt head upward.

Along with weaker balance sheets, younger adults have less experience managing their finances through a period of rising borrowing costs and prices, said Larry D. Compeau, executive director of the Society of Consumer Psychology.

People who lived through the 1970s and '80s probably will respond by tightening their belts appropriately, he said. "But I fear for those who did not experience that time period," because they may not pull back as they probably should, he said. "Their responses may pose significant challenges for themselves and the economy."

Rising interest rates also may push some houses out of reach for many buyers, and force sellers to accept lower prices.

"People are absolutely right to respond powerfully to changes in interest rates, even if they are very low," said George Loewenstein, a professor of economics and psychology at Carnegie Mellon University. Rising rates "may have very serious effects on housing prices," he said, adding that the effects for some households with adjustable-rate mortgages "could be catastrophic."

Another danger for the economy is that older consumers will pull back too much because they lived through those bad times and now have an exaggerated fear of the rate and price increases to come.

One key to consumer response will be the pace of change, Loewenstein said. "People can get used to almost anything," he said, provided changes are gradual. He cited the proverb that says a frog dropped into boiling water will try to jump out, but a frog dropped into lukewarm water that is slowly raised to boiling stays in until too late.

This is one reason the Fed has signaled that it probably will raise rates at a "measured" pace. Its officials are well aware that many investors had serious trouble adjusting to a rapid series of Fed rate hikes in 1994, when it raised the target for a key short-term interest rate from 3 percent to 6 percent over 12 months. And Fed officials believe they can afford to raise their target more gradually from its current, very low, 1 percent level because inflation and other rates are also rising from very low levels.

Bernanke argued that improved monetary policy deserves a large share of the credit for the more stable economy, and said that makes him "optimistic for the future, because I am confident that monetary policymakers will not forget the lessons of the 1970s."