Changes In Interest Rates

By: EconomyWatch Content   Date: 30 October 2009

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Changes in interest rates are largely driven by the demand for and the supply of credit, which in turn depends on the overall health of the economy and the inflation scenario. The general rule for interest rate movements is that good economic growth results in higher interest rates, while a sluggish economy will exert pressure on the interest rates.

Changes in Interest Rates: Driven by Complex Factors

Changes in interest rates are a result of several complex factors. The foremost among these factors is a change in the demand for and supply of funds. A country’s central bank uses changes in interest rates as to tool to maintain a balance and ensure adequate economic growth. A loose monetary policy indicates that the government has printed more money and raised the availability, resulting in a decline in the interest rates. Similarly, if the supply of money is restricted through a tight monetary policy, interest rates will go up.

Inflation is another major factor driving changes in interest rates. Higher inflation is generally associated with a growing economy and is generally followed by an increase in the interest rates.

 

Economic Activity and Changes in Interest Rates

Interest rate changes have a significant impact on the spending and saving decisions of individuals and companies. However, there is generally a time lag between interest rate changes and the resultant changes in the demand, output and inflation levels. Also, the impact of changes in the base interest rates is not uniform across the economy with some segments being more exposed than others.

Higher interest rates boost the cost of borrowing and exert pressure on the demand for mortgages and other forms of lending. They have a negative impact on consumer and business confidence. Similarly, a reduction in interest rates will encourage people to increasingly use the varied forms of credit and boost the purchase of big ticket consumer durables and general spending. Business houses will be encouraged to make increased investments if the interest rates decline. Interest rate movements also tend to impact the foreign exchange rates and, thus, a country’s level of trade.

Changes in various types and categories of interest rates are basically dependant on the base rate or the prime lending rate set by the central bank of a country.


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