Understanding the Rise and Fall of Interest Rates

The rise and fall in interest rates affects everyone. In reality there are two types of interest rates, long term and short term. The long-term interest rates are basic steered by the money markets and they work on the basis of deciding economic factors in advance of them happening.

Short-term interest rates are the ones that more directly affect the general public. These are controlled by the Federal Reserve Board and are the interest that the FRB charges other banks, who in turn charge us. This directly affects our pocket

If the economy is performing too well, borrowing is high and inflation is climbing, the FRB is likely to step in and increase the interest rate. The intention is to slow the economy down a little. They hope to achieve this by reducing the amount of borrowing and the debt levels. If effective, this should slow down the inflation rate. In basic terms high inflation means that you pay more for goods and services from the same salary base.

When the economy is slowing down, the FRB might raise rates. For example, if jobs are being cut, business orders begin to slow down and generally there is little movement in terms of commercial expansion that is a slowdown.

Therefore it can be seen the inflation is the key to the rise and fall of interest rates. Of course, the difficulty is that inflation is not always a result of a nation’s internal situation, sometimes external factors can seriously affect it. For example, with the current middle east crisis (summer 2006), this has significantly affected oil prices. As they rise they will have an impact on inflation, upwards. If that impact becomes to great, ie: the prices rise too much, then the FRB might have to step in to adjust interest rates.