The past few decades has seen the world transform in different political, economic, and social ways. The world wars and the Cold War ended as well as the mighty fall of the Soviet Union. Communist rule paved way for transitional economies in many European countries and Russia. Germany United and the European Union expanded amidst setbacks. Japan faced the “bubble” of 1980 but managed to rescue its dangling economy (Homer, 1996). Latin America struggled with debt problems as well as Mexico and Argentina. Meanwhile, the periods saw China and India emerging as economic powers. As a result of these events, more open-minded trading and financial systems emerged. The currency and the capital markets of the traditional industrial economies massively integrated and the rate of globalization led to more reliable financial systems. Many countries such as the United States began to look for approaches to reduce the increasing state fiscal deficits through regulatory models. The most common ways used by many countries across the world to regulate the economy involved the application of interest rates. Therefore, this essay will talk about the effects of interest rates on an economy throughout history.
Interest rates keep changing over time. Those that operated a month or a year ago may not be the ones that are in use today. It has been established the reason for interest rates not coming down. First, the variations in the economic growth of countries determine the percentages of interest rates the government will impose on a state. Secondly, interest rates may vary because of the different expectations of borrowers and lenders in line with the prospective intensity of prices. Interest rates can be compared to traffic signals directing cars and motorists on a busy highway. Just like the lights, they direct the stream of funds from the banks to the borrowers. In his book Hamlet , Shakespeare once quoted, “neither a borrower, nor lender is for loan oft loses both itself and friend, and borrowing dulls the edge of husbandry”. In the United States, the Federal Reserve uses the monetary policy to regulate the interest rates and credit regulations. The procedure enables the Fed to alter the interest rates depending on the state of the economy. For instance in 2015, the Federal Open Market Committee felt the need to increase the interests rates before the inflation charges increased to a recession level (Torry, 2016).
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Even though some countries may experience high-interest rates, they play a tremendous role in the growth or fall of an economy. It affects important factors in a country’s economy such as business expenditures, income, price levels, the Gross National Product, and the Gross Domestic Product. It can be argued that interest rates facilitate the financial markets and increase the investment opportunities thereby promoting the welfare of the citizens and economic growth.
The early ninetieth century registered a rise in the rates of interest forcing many long-term markets to experience high prime credits than never experienced. The United States employed the highest prime rates in this century and closely following it was England and Holland. In simpler terms, since the existence of contemporary capital markets, the world has never recorded high-interest rates as seen in the in a quarter century ago. However, since the beginning of 1980, statistics have indicated the interest rates to reduce. It is fundamental to note that the trends of interest rates are hard to predict with the current nature of globalization. The inconsistencies in economic fluctuations of different countries leave them with a demanding financial decision to be made. While other countries may increase their interest rates to match the competitive market, others will tend to reduce the rates because of economic stability in place.
On-going researchers over the decades have tried to merge the elements of finance and monetary economics to validate the relationship the relationship existing between interest rates and the economy.
Many countries have financial regulation institutions that monitor financial credit constancy and accountability. The chief regulator for finances in several countries is normally the central bank. Additionally, there is a category known as the real interest rate that results from inflation. They determine household and firms decision which integrate to form aggregate demand. It means the curve of demands for goods is not entirely dependent on nominal interest rate but also influenced by likely inflation. Therefore, in many financial sectors, the central bank cannot determine the real interest rates since the expected inflation may be unpredictable (Torry, 2016).
In a Wall Street Journal article, titled the management of International Monetary Fund (IMF), Christine Lagarde stated that negative interest rates are mediums for improved economic growth (Fairless, 2016). The statement arose from the basis that some central banks authorized unorthodox monetary policies that diminished the potential for economic growth. According to her, the introduction of positive interests would gradually raise the global economy. She encourages the European Central Bank, United States Federal Reserve, and other financial institutions to adopt growth-oriented reforms. However, the negative interest rates should be observed because they would render the world cashless.
In China, the Vice-governor of the People’s Bank Yi Gang stated in an interview that the country was not likely to adopt negative interest rates (QI, 2016). The current rates of interest imposed by the Chinese central bank affect the economy negatively. Even though the economic growth in China has substantially plunged, Yi Gang maintains that they have an abundance of foreign currencies to deal with the capital outflows. Based on this Chinese situation, it is evident that the types of interest rates can momentously manipulate the financial reserves and interfere with the economic growth. The repercussions may not be seen immediately, but the gradual process of capital loss can lead to economic recession.
Moreover, the Wall Street Journal recently published the stand of the Federal Reserve concerning hastily increasing the interest rates. Initially, they had decided to higher the rates, but due to the gradual market growth and volatility, they decided to hold on to the idea until stability was regained. The recent varied economic signals have left the Federal Reserve undecided on when to raise the interest rates. However, they believe that doing so with time reinforces the job market and other economic factors. Currently, the percentage of interest rate is 2 percent (Economic Forecasting Survey, 2016). Even though stalling to increase the interest rates may have adverse impacts on the economy such as unemployment, the Federal Reserve is determined to wait until the rates surpass the standard two percent target. The tactic here is for them to raise the interest rates gradually until economic stability is realized.
Several factors influence the rise and fall of interest rates. The most common factors that are similar to almost all countries include the state of inflation, fiscal policy position, and lender cost. Many countries face the challenge of maintaining price constancy due to liquidity issues. High rates of liquidity put a lot of pressure on the central banks to raise the interest rates. To deal with such situations, financial regulators can raise the borrowing and the lending rates. Secondly, fiscal policies help in fixing the budget deficits. When a country experiences such shortages, they may be forced to borrow money from foreign governments or the local market. Massive deficits increase the demands for borrowing thereby increasing the financial gap. As a result, there is will be a strain on the domestic market to keep up with the difference hence the interest rates will increase to cover the costs. Lastly, when a bank lends people money, they incur costs for their services. Assuming their borrowing rates are high, then it means the interest rates will be higher. Banking institutions are types of businesses, and their key goal is to make profits just like any other organizations. Consequently, interest rates can be affected by the maturity period of borrowed finances. Long-term maturity tend to have higher chances of incurring losses, therefore, it is most likely that the interest rates will increase.
In conclusion, there are a few ways for countries to stabilize their interest rates instead of acutely increasing or decreasing the rates. For instance, they can adopt the approach of overnight borrowing or lending to lever the inflation mark. Also, monetary policies should be monitored because interest rates rise steadily. It is with no doubts that a strong relationship exists between the interest rates and economic growth (Bosworth B. , 2014).
References
Bosworth, B. (2014). Interest Rates and Economic Growth: Are They Related? Center for Retirement Research at Boston College Working Paper , 2014-8.
Economic Forecasting Survey . (2016, April 12). Retrieved April 12, 2016, from Wall Street Journal: http://projects.wsj.com/econforecast/#ind=gdp&r=20
Fairless, T. (2016, April 5). Market Watch . Retrieved April 12, 2016, from Wall Street Journal: http://www.marketwatch.com/story/negative-interest-rates-are-net-positives-for-global- economy-says-imf-chief-lagarde-2016-04-05
Harrison, D. (2016, April 10). Market Watch . Retrieved April 12, 2016, from Wall Street Journal: http://www.wsj.com/articles/government-spending-cuts-escalate-clashes-over-monetary- policy-1460312664
Homer, S. &. (1996). A history of interest rates. Rutgers University Press.
QI, L. (2016, March 7). Market Watch . Retrieved April 12, 2016, from Wall Street Journal: http://www.marketwatch.com/story/china-unlikely-to-impose-negative-rates-official-says- 2016-03-06
Torry, H. (2016, March 16). Market Watch . Retrieved April 12, 2016, from Wall Street Journal: http://www.wsj.com/articles/fed-leaves-interest-rates-unchanged-lowers-outlook-for- further-increases-1458151656
