➨ When a central bank raise interest rates it is a big news. it can create ripple effect across the whole economy.
It can sink consumer's confidence and resulting in fewer jobs, lower wages and cause stock price to fall.
What are interest rates?
Suppose if you borrow money you have to pay back little extra to make it worth while to lender. This is interest rate. So if you taking out a loan you want to be interest rates as low as possible so you don't have to pay that much back.
➱ On the other side, if you want to save money than a high interest rate means you cane earn more on savings.
➱ There is no single interest rate in economy, you got thousands of banks setting on their own commercial rates that all influence the interest rate central bank sets.
What do central bank do?
A central bank is like a bank for banks, just like you and your savings account, banks also earn interest when they leave money with central bank.
➱ Commercial banks have these things called reserves so it is bit like cash in hand, commercial bank lend those excess reserve to each other at an interest rate and they can also deposit their excess reserve at the central bank. when they do that they can earn an interest rates.
➱ Some time central banks raise/decrease interest rates.
Why do central banks raise interest rates?
The idea behind, when central bank raise interest rates they are trying to control inflation. How fast prices rise for everyone.
➧ A rise in interest rates from central banks means that a commercial bank will earn more on their reserve. they might make more from keeping their money in the central bank than lending it out.
So if they do lend it out they will raise their interest rates to make it their worth in while.
How do raised interest rates affect consumers?
➧Suppose if you got variable rate mortgage where interest rates you pay is linked to the central banks interest rates than high interest rate means the essential immediately the higher rate will translate into less cash spend on other things.
➱ less spare cash means house hold will spend less and spending means businesses will be barrier raising price this should lower inflation.
➧ In other hand, countries like America or Canada a bigger share of mortgage is at fixed rate. people with fixed rates are protected against the direct effect of an interest rate rise but they still feel the indirect effect.
➱ High interest rate means that the mortgage will become more expensive, if that is affecting all new buyers then house price will begun to fall and that will make every one who owns home feel poorer and their for they might spend less. Lower spending will translate into lower inflation.
➱ And it is not just consumer who are tighten their purses....
How do raised interest rates affect business?
➧ When interest rate rise then businesses will find more expensive to borrow and invest that generally mean less economic activities it might mean fewer jobs are created.
➱ Fewer jobs or wages could mean less money for households and consumer confidence might suffer which also mean less spending.
➧ When interest rate rise that will tend to slow down spending, investment and generally depress economical activity overall. that will make business more reluctant to rise their prices and that will tend to pull back inflation.
➱ A little inflation is okay. it keep the economy moving at a sensible speed but, if inflation stayed high for too long is a problem. Higher prices means employee will need higher salary and wages pushing up the cost of businesses, that could drive up price further potentially leading to an upward Spiros of salary and wages.
What are the risks of raising interest rates?
➧ Raising interest rate can slow down an economy. central bank know this so when they sets interest rate they are actually trying to read the road ahead but, predicting the future isn't easy.
💢 Central bank would say "yes" rising interest rate can be painful, slowing down the economy but it wort it.. it worth it to get low and steady inflation so that in the long run you don't have to think about it.
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