Why change interest rates?


Interest is simply the cost of borrowing money. As with any product or service in a market economy, price ultimately boils down to supply and demand. When demand is weak, lenders charge less to part with their cash; when demand is strong, they can raise fees, the interest rate aka. The demand for funding ebbs and flows with the business cycle. In a recession fewer people looking for new mortgages or loans to start or expand business. Seek to increase lending, banks put their money “on sale” by dropping the speed.

Supply changes in economic conditions fluctuate. In this regard, the government plays a major role. Central banks like the Federal reserve tend to buy government debt during the economic downturn, pumping the stagnant economy with cash that can be used for new loans. The increase in supply combined with lower demand, forcing prices down. The opposite occurs during an economic boom.

It is important to note that short-term loans and long term loans can affect very different factors. For example, buying and selling of securities by the Central Bank has a much greater impact on short-term loans, such as rates on credit cards and auto loans. For longer notes, such as 30-year Treasury bonds, the Outlook for inflation may be an important factor. If consumers are concerned about the value of money will decline rapidly, they will demand a higher rate on their “credit” to the government. (For associated reading, see: why interest rates usually have an inverse relationship with prices?)

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