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Lowering interest rates can stimulate consumer spending, but can also harm financial institutions and lead to job cuts. Governments use interest rates to manage the economy, but it should not be viewed as a quick fix.
The practice of lowering interest rates is something that almost every country has done from time to time. While some people believe that lowering interest rates is always a good thing, that is not necessarily the case. While lower interest rates can certainly have beneficial effects for some parts of the economy, there is also the potential to harm other sectors. Here are some examples of when lowering interest rates can be helpful and when action could lead to economic hardship for a given country.
One of the immediate benefits of lowering interest rates is that the action can stimulate consumers to buy more down the road or property, goods, and services. Because interest rates are lower, some larger purchases are perceived by the typical consumer to be more affordable, since the purchase will ultimately include a smaller amount of financing in the final price. People are more receptive to applying for credit to finance high-value items, such as a new home or vehicle. Even consumers who aren’t in the market for a major purchase tend to use credit cards with a bit more abandon. From this perspective, lowering the interest rate is a great way to stimulate a sluggish economy and get people back into the stores.
At the same time, cutting interest rates can have some devastating consequences on the back-end. Interest income helps maintain the operation of many financial institutions. When the interest rate is reduced, that means that the income for those institutions is also reduced. Depending on the current economic climate, this can lead to cutbacks that may include discontinuation of services to consumers, as well as job cuts. With more people out of work, there is less disposable income to circulate through the economy. When interest rates are lowered during a period of inflation, this can often lead to an increase in the problem rather than a reduction in it.
Governments often consider lowering interest rates periodically, even in times of recession. In the United States, the Federal Reserve will often lead the implementation of the reduction. The interest rate decrease is normally announced by the Federal Reserve Bank system and all affiliated banks immediately implement the change. At the same time, the Fed will also be the instrument through which interest rates will be increased, if the government determines that it is in the best interest of the economy.
Lowering interest rates is often presented as desirable and as having little long-term consequence. While there are situations where lowering the current interest rate is helpful to the economy, it should never be viewed as a quick and simple fix that won’t have some consequences at the end of the day.
Smart Asset.
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