In general, as interest rates are reduced, more people are able to borrow more money.
The result is that consumers have more money to spend, causing the economy to grow and inflation to increase.
The opposite holds true for rising interest rates.
How does real interest rate affect economic growth?
An increase in real gross domestic product (i.e., economic growth), ceteris paribus, will cause an increase in average interest rates in an economy. In contrast, a decrease in real GDP (a recession), ceteris paribus, will cause a decrease in average interest rates in an economy.
How can interest rates increase economic growth?
The Fed lowers interest rates in order to stimulate economic growth. Lower financing costs can encourage borrowing and investing. On the other hand, when there is too much growth the Fed raises interest rates. Rate increases are used to slow inflation and return growth to more sustainable levels.
What happens when interest rates rise?
Because higher interest rates mean higher borrowing costs, people will eventually start spending less. The demand for goods and services will then drop, which will cause inflation to fall. Inflation was at 14% a year, and the Fed raised interest rates to 20%.
Why do stocks fall when interest rates rise?
As interest rates move up, the cost of borrowing becomes more expensive. This means demand for lower-yield bonds will drop, causing their price to drop. A decrease in interest rates will prompt investors to move money from the bond market to the equity market, which then starts to rise with the influx of new capital.