Interest rates and their impact
Interest rates, in any economy, are controlled by the Central Bank using the monetary policy. Central banks often lower rates during economic recessions mainly to increase investment spending that will later improve economic growth. Reduction of interest rates affects both the consumer and the economy.
Effects on consumer savings
Low-interest rates reduce the interest earned on savings leaving the consumers with only two options. One, the substitution effect, where the consumers will find it more beneficial to hold on to their money other than save it. Consumers will, therefore, have a lot of money at their disposal which in turn encourages more spending. The other option is the income effect. The consumers will increase the amounts of savings to match up their expected returns from interest. Investments such as Stocks also attract low dividend payments at the end of a financial year due to the interest rate cuts. For the consumers that invest in certificates of deposits, their previous investment will remain closed in the previously higher rates and will not be affected by the rate reduction. New CDs, however, will attract the lower rates making them less profitable for the consumers and thus they may opt out of new purchases (Goodhart, 2013).
Positive outcomes for consumers
Despite having a negative impact on consumer savings, interest rate cuts also have some positive outcome for consumers. Low rates lower the cost of borrowing, and thus consumer can get cheaper loans. For example, mortgage repayments and monthly instalments on loans will be more affordable leaving the consumer with some money to consume. Consumers may prefer to buy assets during the period of rate reduction. Cheap and readily available loans make the assets appear more affordable. This will drive the prices of assets up though (Ma, Xiandong " Xi, 2013).
References
Goodhart, C. A. E. (2013). The potential instruments of monetary policy. Financial Markets Group Research Centre, London School of Economics and Political Science.
Ma, G., Xiandong, Y., " Xi, L. (2013). China’s evolving reserve requirements. Journal of Chinese Economic and Business Studies, 11(2), 117-137.
Nationalbank, D. (2014). Interest rate reduction. URL: http://www. nationalbanken. dk/en/pressroom/Documents/2014/09/DNN201420974. pdf, 4, 2014.
