Finance, Forex and Investments

Interest Rates?

What effect does lowering the interest rates have on the economy? Effect of highering?

Public Comments

1. Think of the interest rate as the price of capital, one of the three fundamental resources (the other two being labor and land, where land includes natural resources.) What effect would raising the price of a fundamental resource be? There's your answer.
2. Lower interest rates makes it more appealing for people to borrow. If interest rates are going down, people will borrow more and more. If interest rates are going up, people borrow less and less. What happens to borrowed money? It gets spent or invested. Spending means more revenue for small businesses and corporations. More revenue means higher earnings. Higher earnings means the stock market goes up. The billions of dollars that people borrow causes inflation, so if the Fed lowers the interest rates, it causes inflation but it helps the stock market at the same time. If the Fed raises the interest rates too high, it tries to protect the value of the dollar while stocks go down. The Fed has the power to lower or raise interest rates, and so it's like having a switch that can turn summer into winter or winter into summer. The Fed can create economic boom or bust depending on how it adjusts the interest rate. You shouldn't think that the Fed controls the entire economy, because that's not true. There are many other factors that influence the American economy. The Fed is one of them.
3. Demand - If interest rates come down, it is likely that demand increases, especially for big ticket items will increase. This is because the cost to purchase them has actually come down as the cost to finance them is lower. Housing and automobiles are traditional good examples of this. Increase in demand means supplies will produce more to meet it and may hire more employees. Consumers may also have been saving their money earning high returns based on the interest rates. They may now have more of an incentive to spend some of their savings. Supply - If interest rates come down, it is likely that supply increases as the cost to finance a business or factory is lower. Suppliers are more likely to borrow money and expand, renovate, modernize or start up as it costs less to finance. New start ups and expansions are likely to mean more hiring. Suppliers may have savings they had invested in high return investments. The rate of return on those will come down with the fall in interest rates, so they might look to spend on an expansion as they assess what types of comparative returns they can get in expanding.