Effects of Interest Rate Variation- All You Need to Know!

Any modification in interest rates made by the FED can have both bad and good consequences on the country's economy, without there being an infallible rule or manual of what will happen, as various variables converge in the economy.

Variation of the interest rate.

The interest rate is always fluctuating, sometimes going up, sometimes down, and sometimes keeping the same, depending on the market conditions.

The variation of the interest rate is marked by the central bank, such as the Federal Reserve, and is due to the economic policy followed by the bank according to the objectives pursued.

The interest rate established by the central bank determines the cost of borrowing that is transmitted to private banks and ultimately to the final financial consumer, which includes the corporate sector and the general public, respectively.

Effects of the interest rate.

A change in the interest rate has a direct impact on the economy, regardless of whether the rate rises, falls, or stays the same.

What is the impact of the increase in the interest rate on you?

  1. When the interest rate goes up, the cost of borrowing goes up as well, which makes it more difficult for businesses to fund investments and makes it more difficult for people to spend their money.
  2. It is also possible that this will have an impact on the level of unemployment, due to the same difficulty that businesses are experiencing in financing their growth and development as a result of the increase in credit costs, which reduces consumption, and if consumption decreases, employment also tends to decrease, depending on how much the productive sector is forced to reduce supply, and in order to reduce supply, it is necessary to reduce production.
  3. Demand is diminished as a result of credit being more costly since consumers will be less likely to use their credit cards or take out consumer loans as a result of this.
  4. When interest rates are high, it is more appealing to save than to spend, and many people will opt to save rather than spend, contributing to the contraction of demand.
  5. Because a decline in consumption has a direct impact on demand, inflation tends to fall as a result of the oversupply that arises as a result of a decrease in demand.

What effect does it have on the reduction in the interest rate?

  1. In the opposite situation, when interest rates fall, the cost of borrowing falls as well, making it more attractive to finance projects and so contributing to a rise in both output and job opportunities.
  2. In the same way, as interest rates fall, spending rises, particularly consumption supported by credit, which in turn raises both output and demand.
  3. Inflation is defined as an increase in the price of both production costs and finished products and services as a direct result of an increase in demand, which is a phenomenon known as inflation.
  4. Reduced interest rates make it less appealing to save and invest in industries whose profitability is influenced by interest rates. As a result, many investors opt to purchase foreign currency, therefore increasing the value of the currency in their possession.
  5. When the interest rate lowers, the value of the dollar tends to climb because it may now be more appealing to buy dollars rather than to hold low-interest savings accounts, according to the Federal Reserve.

Globalized interest rate.

In a globalised world, not only does the behaviour of local interest rates matter, but so does the behaviour of interest rates in other nations, such as the United States, Japan, and the European Union, to a significant extent.

When interest rates in the United States fall, for example, investors prefer to transfer their funds to other nations where they may make a more profitable investment. Therefore, when the Federal Reserve in the United States decides to cut the interest rate, an avalanche of dollars might be created in the nation, forcing the interest rate down and harming exporters in the process.

In the economy, the interest rate is expressed as a percentage!

The economy is affected by each of the variables and situations; however, the economy cannot be evaluated on the basis of a single variable or situation, but rather on the behaviour of all the variables and elements that make up the economy, which is extremely complex., that throughout history, no state has found the correct treatment for the different variables or the economy in general; and this is even more true in a globalised world where both positive and negative situations exist.

Of course, the expected situation according to theory does not always occur, because the economy moves on the basis of a large number of variables, and the behaviour of some can cancel out the expected behaviour of others, so that in economics nothing is certain and nothing is precisely predictable, and everything is subject to uncertainty.

For example, the general rule is that when the price of oil rises, the Colombian dollar falls; however, there are times when this is not the case and everything appears to be going against the grain. This is due to the fact that, in addition to the price of oil, there are other factors that weigh more heavily on the price of the dollar at certain times.

What is the relationship between investment and the interest rate in terms of the growth and development of an economy?

As previously said, the interest rate has a direct impact on the investment, and the type of investment that is planned will determine how much influence the interest rate has on the investment.

When a company, for example, faces an increase in interest rates, the financing of investment becomes more expensive, and the company is more likely to decide not to invest in expanding its production capacity, reducing the country's competitiveness as a result, making it more expensive to invest in the real economy.

Increases in interest rates, on the other hand, can favour other types of investments, such as financial or speculative ones, because the returns on financial investments, such as a simple DTF, are favoured by increases in interest rates, and as a result, when interest rates rise, the savings rate tends to rise as well.

According to the information shown above, the interest rate and investments, which are intimately associated, have an impact on the growth of an economy.

The impact of interest rates on the state's financial situation!

Due to the fact that the state has revenue and costs, and in particular, a large amount of debt, the state operates similarly to a business or a family; consequently, an increase in the interest rate will raise the cost of that debt, harming the state's financial situation.

Because the state is not an investor, but rather a high-spending debtor, an increase in interest rates typically results in significant strain on public finances.


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