INTEREST RATES

Interest rates

Interest rates

What are Interest rates?

Interest is the payment to the lender for the use of borrowed money or financial capital. Interest paid because the value of money depreciates over time as prices rise. Compensation required for that loss and the postponement of consumption. Interest also paid to minimize the cost of default. The nominal-interest rate is a combination of expected inflation and the real-interest rate, whereas the real-interest rate is the difference between the nominal rate and expected inflation. The interest rate is normally one of the most telling indicators of whether people will be willing to hold more or less money. When the interest rate is high, people tend to hold less money and more money when it is low. The monetary policy, which designed by government, and the market forces are the main reason behind the setting of interest rates. The interest rate features the business activity on a macroeconomic scale. Interest rates and cost of borrowing directly related to each other. When interest rates are high, cost of borrowing also increases. When interest rates are low, cost of borrowing also decreases. The decline in the overall investment has an adverse effect on national income and the economic activity, as they also decreases. When interest rates are low, the opposite thing happens.

As previously mentioned above, the interest rates determined by the market forces and the monetary policy. The monetary policy is a set of policy which designed by the government in order to control the inflationary rate in the economy. Monetary policies determined by the amount of money supply. If the inflation rate is high, the government increases the supply of money so that more money can be put in the market for the consumers. When the interest rates are low, expansionary monetary policy is wittiness in which the supply of money decreased (Metal, 2002, pp. 16).

The effect of high interest rates

Household budgets

The overall economy influenced by the power of house hold sector. This is because of the size of the house hold sector also it immense exposure to the financial institutions. The financial institutions deal with the money of the household. When there is a change in the budget and balance sheet of the household, it will have a direct impact on the financial institutions. Particularly talking about the household budget, inflation has a drastic impact on it. As we all know, that an earning of person of a household limited in nature. The income of that individual is constant and only changes under very rare circumstances. On the other hand, inflation is the rise in the general price level of commodities. If the interest rates are increasing at a huge, the household budget be greatly affected. High inflation rate increases the price of commodities and reduces the purchasing power of an individual.

According to the research, household budget is decreased due to rising inflation rate. All the extra expenditures are cut down and the household is only focusing on fulfilling the basic necessities of life ...