In this article, we cover factors that affect Interest Rates. The Interest rates influence how businesses and individuals borrow and spend. It is a monetary policy tool that is utilized by the U.S. Federal Reserve when it begins its journey to achieve maximum employment, price stability, and moderate long-term interest rates.
It is the Federal Funds Rate that influences other Interest rates. Federal Funds Rate is the rate at which banks borrow overnight in the Federal Funds market. And, Changes to Federal Funds Rate influence borrowing costs for both businesses and households.
Factors that Affect Interest Rates
Inflation: It is one of the most important factors. The U.S. Federal Reserve strives to achieve price stability. If the rate of inflation rises over the Central Banks’ target, then we can expect the U.S. Federal Reserve to increase Federal Funds Rate. And, decreases if the inflation goes below its target.
Strength of the economy: If the economy isn’t doing well, then to stimulate the economy, the U.S. Federal Reserve would lower the interest rates. If it goes down well below the level where businesses and individuals find it attractive to invest then it would revive the economy. On the other hand, if the economy is running hot and the demand for money is higher than the supply then, it would make the U.S. Federal Reserve increase the Federal Funds Rate.
The strength of the economy also serves the purpose of achieving maximum employment. Apart from other things, we need human resources to produce goods and services that are in demand. And, if the economy functions well, it results in lower unemployment.
These two are the fundamental factors that affect the interest rate decision of any central bank. Other factors like Fiscal deficit/Government borrowing, foreign exchange rates, etc. do influence interest rate decisions made by the Central Bank but not by much.
In conclusion, we have covered here two factors that affect interest rates: Inflation and the Strength of the economy.
