What is Low Interest Rate Environment
A low interest rate environment occurs when the risk-free rate of interest, typically set by a central bank, is lower than the historic average for a prolonged period of time.
BREAKING DOWN Low Interest Rate Environment
Much of the developed world has experienced a low interest rate environment since 2009 as monetary authorities from around the globe cut interest rates to effectively 0 percent in order to stimulate economic growth and prevent deflation.
Low interest rate environments are meant to stimulate economic growth by making it cheaper to borrow money to finance investment in both physical and financial assets. One special form of low interest rates is negative interest rates. This type of monetary policy is unconventional in that depositors must pay the central bank (and in some cases, private banks) to hold their money, rather than receiving interest on their deposits.
Like anything else, there are always two sides to every coin—low interest rates can be both a boon and curse to those affected.
Who Benefits from a Low Interest Rate Environment?
The Federal Reserve lowers interest rates in order to stimulate growth during a period of economic decline. That means that borrowing costs become cheaper.
A low interest rate environment is great for homeowners because it will reduce their monthly mortgage payment. Similarly, prospective homeowners might be enticed into the market because of the cheaper costs. Low interest rates mean more spending money in consumers' pockets. That also means they may be willing to make larger purchases and will borrow more, which spurs demand for household goods. This is an added benefit to financial institutions because banks are able to lend more. The environment also helps businesses make large purchases and boost their capital.
Costs of Low Interest Rate Environment
Just as there are advantages, there are also drawbacks to a low interest rate environment, especially if the rates are kept extremely low for a long period of time. Lower borrowing rates mean investments are also affected, so anyone putting money into a savings account or a similar vehicle won't see much of a return during this type of environment. Bank deposits will drop, but so will bank profitability because cheaper borrowing costs will result in a decrease in interest income. These periods will increase the amount of debt people are willing to take on, which could be a problem for both banks and consumers when interest rates begin to rise.