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. Does cash-on-delivery aid produce better results than a loan?

    Learn of the arguments about the efficacy of cash on delivery, or COD, aid to poor areas, as set forth by its proponents ...
  2. What are some alternatives to real GDP?

    Learn about economic measures used instead of real GDP and the limitations of real GDP. Find out in which situations nominal ...
  3. How much of an economy's performance is captured by real GPD?

    Learn about the economic information captured by real GDP. Find out how real and nominal GDP are constructed and the purposes ...
  4. How does inflation affect the exchange rate between two nations?

    Understand how inflation can affect foreign exchange rates of a currency and how it is just one of many economic factors ...
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

    What Has Been Groupon’s Growth Strategy?

  2. Mutual Funds & ETFs

    TIPS ETFs: No Inflation, No Reason to ...

  3. Economics

    The Economic Impact of Better US-Cuba ...

  4. Stock Analysis

    SLV Likely To Bring Pain...And Rewards

  5. Stock Analysis

    Is This The Right Way To Invest In Silver?

Trading Center