We all know that interest rates seem to bounce around throughout the ages. What we might not know is how interest rates affect the overall economy and how these economic changes affect us. The economy thrives off people’s ability to purchase products and how much investment the country can draw and interest rates are a good sign as to what part of the cycle we exist in.
Interest rates are defined as the cost of borrowing money. The higher the interest rate the more expensive it becomes to buy a house, car or purchase new items on your credit card. When products become more expensive people will purchase less items and this means stores aren’t selling as much.
However, as the interest rates go up people invest less in their businesses and people purchase less products. For example, if you needed to purchase a new piece of equipment for your business and the interest rate is low (the cost of borrowing money) you may go ahead and make the purchase. Yet, if the interest rate is high (the cost of borrowing money) then you may forgo the new purchase or expansion because of its cost.
When companies are not purchasing new equipment to use in their expansion and people are not purchasing more products what do you think happens to the employment market? The amount of new jobs available declines leaving consumers with less opportunity to purchase new products.
If the cycle becomes poor enough the country can slip into a recession or depression that can seriously affect people’s lifestyles. A recession happens when this cycle of low and high interest rates become stuck on the high side and the country begins to leak jobs for easier business environments.
When interest rates are higher in the United States foreign companies and people try and invest their money because they get a higher rate of return. For example, an interest rate of 10% would mean that someone investing in the U.S. might earn around a 10% return on their money. As more people invest and the economy improves the interest rate drops.
Once these investors flood the market with investment money interest rates decline because it is easier to borrow money. The cycle of high and low interest rates adjusting automatically is one of the tenets of a laze-fare market. When this process works properly the market is self-regulatory. When government legislates they can either be improving this process or hampering it.