High interest rates create an unwillingness to spend money. Because consumers know that they will pay more over the course of the loan, they might choose to postpone buying high items such as cars and homes. Higher interest rates cause deflation, which means the purchasing power of the dollar is stronger. Debt deflation reduces personal wealth and aggravates an economic downturn. Many parties control interest rates, including banks and, the Federal Reserve. These institutions decide which interest rates to charge to other banks, companies in need of business loans and individuals wishing to buy a mortgage.
The rate charged to consumers is not compatible: While borrowers with a high credit score receive lower interest rates, people with poor credit scores receive higher interest rates. Low interest rates affect purchasing habits as well. The Federal Reserve sets a low discount rate to inspire banks to issue more loans to each other and to consumers. When consumers and businesses have easier access to credit, they spend more money. In most cases, low mortgage rates equate to more home purchases and low credit card rates cause people to spend more on credit.
However, low interest rates and an increase in the money supply means the dollar weakens. Businesses that rely on foreign vendors will see an increase in the cost of production because of the changes in the exchange rate. Changing the procure routine of banks and consumers through interest rates is a long standing procedure of the Federal Reserve. During the 1970s, low interest rates associated with a large number of women entering the workforce, caused a spending spree that resulted in high inflation.
To reduce the rise in prices the Federal Reserve raised the prime interest rate to 21. 5 percent in December1980. When the economy is in a deep recession and the unemployment rate is high, setting low interest rates has little effect on consumer purchasing. When the Federal Reserve could not use interest rates to influence monetary policy or purchasing decisions, it is stuck in what is called a “liquidity trap. ” This occurred in 2010 when the Federal Reserve set interest rates to near zero percent with little effect on jump-starting the economy.