What Are the Causes of High Interest Rates?

High interest rates are attractive for savers looking to build cash reserves.

Interest rates are primary economic indicators that describe the costs of money. Higher rates are associated with relatively high demands for capital. Evaluate the reasons behind high interest rates before making financial decisions.

Identification

High interest rates signal that banks are demanding more compensation for making loans. Meanwhile, the Federal Reserve Board balances economic growth and inflation concerns. The Fed slows down the economy with higher interest rates to contain inflation.

Features

The federal funds rate affects all interest rates. The federal funds rate refers to interest charges on loans between banks for their reserves held at the Fed. The Fed reduces the money supply through open-market operations, which effectively increase interest rates.

Considerations

High interest rates are also associated with risk. Less creditworthy borrowers must make higher interest payments to compensate lenders for increased default risks.

Benefits

Fixed-income investments, such as bonds and certificates of deposit, pay out more money amidst high interest-rate environments.

Risks

High interest rates may actually confirm high-inflation levels. Inflation decreases the purchasing power for all assets.

References

• Federal Reserve Board: Open Market Operations
• Federal Reserve Board: Federal Open Market Committee
• Investopedia: Inflation

Resources

• Federal Reserve System: Purposes & Functions
• Federal Reserve Board: Intended Federal Funds Rate