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Which is better for an economy with slow growth, to increase or decrease the int

  1. alexandriaruthk profile image76
    alexandriaruthkposted 5 years ago

    Which is better for an economy with slow growth, to increase or decrease the interest rate?

    Increasing the interest rate as a monetary policy will affect for example two important sector - automobile and housing. Some economists argue that lowering the interest rate will help the people cope with their debts. Increasing interest rate is the opposite of just that. What is your opinion?

  2. Gamerelated profile image83
    Gamerelatedposted 5 years ago

    Increasing the interest rate will affect all sectors where people need to borrow money not just the automobile and housing sector.  If money is more expensive to borrow then business will borrow less.  This means that business will have less opportunities to expand.  This translates to slower job growth and possibly even a loss of jobs.  Increasing the interest rate will help to limit inflation, but it comes at a cost.

    Lowering the interest tends to have an expansionary effect, but it also can lead to inflation since you are paying less money to borrow money.  This happens in two ways.  As people borrow more money the amount of money in the economy increases.  As the supply of money increases the value of money declines.  Another effect of lower interest is a reduction in the efficiency of investments.  When you invest borrowed money your return on investment just needs to cover the interest on the loan and the capital in order to turn a profit.  The lower the interest rate the less you have to cover and the less productive you have to be.  A decline in productivity relative to the supply of money can lead to inflation.

    To answer your original question, If it is better to increase the interest rate or decrease the interest rate?  It depends on if you have a lot of money.  The more money you have the more inflation affects you negatively.  The less money you have the less inflation affects you.  The people who borrow money actually benefit from inflation.

    Take hyperinflation for example, I borrow $10 from you and I buy two beers at the bar.  One hour later the price of beer increase by 25% and it is now $12.50 for two beers.  If I pay you back the $10 that I borrowed you will no longer be able to buy two beers.  I have now paid you back money that is worth less than it was when I borrowed it an hour ago.  This is the reason why interest rates also tend to be tied to inflation.  The more people expect inflation to be the more they will charge for interest.  Keeping inflation down tends to benefit the rich because they hold onto more money and they tend to lend more money.  Allowing inflation to happen tends to reduce the value of money and helps poor people, especially if they are in debt. 

    The role of the Federal Reserve Bank is to find a balance, but they tend to err on the side of keeping inflation down which tends to help rich people more than poor people.  Overly focusing on keeping inflation down slows job growth and that hurts poor people too.

 
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