We are always seeing headlines about the interest rates. It goes up and it goes down, but how does this effect you? What’s the big deal? With the Russian economy currently being at an all time low, it seems like a good time to cover this important topic in this article.
First off, we need to explain what interest actually is. A basic definition of interest is…
Interest is a fee paid by the party borrowing an asset to the owner of the asset, as a form of compensation for the use of the said asset. Put simply, if you borrow money from the bank, you need to pay back the sum of money you borrowed plus interest.
The interest rates are controlled by the central banks. If the central bank in the United states raises the interest rate, what does that mean for you and me? Well put simply, it means different things for different people but the overall effect is the same.
What happens when the rate goes up?
Once the interest rate increases this means that money becomes more expensive. If you wanted to get a loan from the bank to buy a new car, this means that the loan is going to be more expensive as you will need to pay more interest on the loan. That in turn means that consumers will decrease their spending. You may ask yourself though, what about people that don’t need loans. Why would they decrease their spending? Well, if you had say $50,000 in your bank account and wanted to buy a car for the said sum, would you buy the car today? Or would you leave the money in the bank and enjoy the high interest rates that could quickly increase the amount of money in your account? Exactly, if i’m getting 10% per month on my money, the new car can wait. So whether you have money or whether you don’t if the interest rates increases you will reduce the amount of shopping you do. This also holds true for entrepreneurs. Why should they work their ass off on new ventures if the can simple relax at home, play Call of Duty and enjoy big returns on their money without doing anything at all? Exactly. It’s a no brainer.
So basically, increasing the interest rate slows down the economy by giving people an incentive to save rather than spend. Why would anyone want that? One reason would be a means of fighting away inflation in a scenario in which it irising too fast.
What happens when the rate goes down?
So what happens if the interest rate is reduced? It’s basically the opposite effect. Money becomes “cheap”. So you can take a loan and buy a new house or car and it won’t cost you much. Also, those who have large amounts of money in their bank accounts have no incentive to keep it there as they are getting next to nothing for it. In fact, if the interest rate is 0%, you are actually losing money by keeping it in the bank, as the inflation is rising faster than the return you’re getting on your money. Therefore, people will seek to start up new ventures and increase investments.
So decreasing the interest rate gives inceptive to spend and invest rather than save. This is a useful method for giving the economy a jump-start during recessions. While the higher the interest rate the more money save and the less they buy.
This is a very basic explanation. There are many more issues and aspects that we haven’t covered but you now have a basic understanding of the consequences and the reasons for raising or lowering the interest rates. Just this month the interest rate in Russia was increased by 6.5% overnight! Did you understand the article? If so, let us know in the comments what you think think about the dramatic overnight increase.
