Why do interest rates change?

By Daniel Kurt AAA
A:

Interest is simply the cost of borrowing money. As with any good or service in a free market economy, price ultimately boils down to supply and demand. When demand is weak, lenders charge less to part with their cash; when demand is strong, they're able to boost the fee. Demand for loans ebbs and flows with the business cycle. During a recession, fewer people are looking for new mortgages or loans for their start-up businesses. Eager to increase lending, banks put their money "on sale" by dropping the rate.

Supply also changes as economic conditions fluctuate. In this regard, the government plays a major role. Central banks like the United States Federal Reserve tend to buy government debt during a downturn, pumping the stagnant economy with cash that can be used for new loans. The increase in supply, combined with diminished demand, forces rates downward. The exact opposite occurs during an economic boom.

It's important to note that short-term loans and long-term loans can be affected by very different factors. For instance, the buying and selling of securities by a central bank has a much greater impact on near-term lending, such as credit card rates and car loans. For lengthier notes, such as a 30-year Treasury bond, the prospects for inflation can be an important factor. If consumers fear the value of their money will rapidly decline, they'll demand a higher rate on their "loan" to the government.

RELATED FAQS

  1. What are some limitations of the consumer price index (CPI)?

    Explore some of the basic limitations of the widely used economic indicator, the consumer price index, or CPI, and examine ...
  2. What is the difference between fiscal policy and monetary policy?

    Utilizing founding principles of macroeconomics through both fiscal and monetary policy can have drastic effects on a country's ...
  3. Can the consumer price index (CPI) for individual areas be used to compare living ...

    Understand why the Consumer Price Index, or CPI, cannot appropriately be used for comparing the cost of living across different ...
  4. Will the consumer price index (CPI) be updated or revised in the future?

    Learn about the consumer price index (CPI) and understand how its purpose and calculation make it necessary to continually ...
RELATED TERMS
  1. Nordic Model

    The social welfare and economic systems adopted by Nordic countries.
  2. Fee Harvesting Card

    Credit cards targeted at consumers with poor credit scores that ...
  3. Zero Percent

    A promotional rate of interest used to entice consumers, often ...
  4. Penalty Repricing

    An increase in a credit card’s interest rate that occurs when ...
  5. Universal Default

    A practice whereby a credit card issuer increases a credit card ...
  6. Wall Street Journal Prime Rate

    An interest rate that large banks in the United States charge ...

You May Also Like

Related Articles
  1. Investing

    Reassessing Your Approach To Bond Investing

  2. Investing Basics

    Five Successful Investing Strategies

  3. Investing

    Will 2015 Finally Be The Year For Rising ...

  4. Economics

    The Economic Impact of Better US-Cuba ...

  5. Economics

    How US & European Union Sanctions Are ...

Trading Center