Factors that Affect Interest Rates

Interest rates are affected by factors such as inflation developments, prospects for the real economy, monetary policy, the forces of demand and supply, global liquidity, inflation, fiscal deficit and government borrowings, international borrowings, stock market conditions, and the Federal Reserve. Items such as employment and economic growth constitute information that provides prospects for the real economy. The Federal Reserve controls the availability of credit and is a significant force in the determination of interest rates and future trends. Monetary policy plays an important role of stabilizing employment and production with a long-term view in addition to stabilizing inflation by aiming for an inflation target. By stabilizing employment and production, monetary policy is best place to achieve high employment and sustainable growth, since it is unable to raise employment and growth more permanently and especially not in the short –term.

The forces of supply and demand for money in an economy are primarily the factors that impact the rates of interest the most in this economic climate. This is because interest rates tend to rise or fall in relation to the demand and supply for money, say for instance that the supply of money exceeds the demand for money in an economy, at that given point interest rates are likely to fall and vice versa. Another illustrative example would be the tightening of monetary policy by a country’s monetary policy, which diminishes the liquidity or money supply in an economy and leads to increased interest rates that effectively reduce inflation but on the other hand results in a low economic growth(Caporale & Pittis, 1997). If however monetary policy is loosened, then the interest rates are reduced and the growth of the economy is stimulated but on the other hand, inflation rises.

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