What Happens When Interest Rates Are High?

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The term "interest rates" refers to the rates at which lenders are lending money to borrowers. Lenders will charge a rate of interest on the principal of these loans as a means of making a profit. While the rate charged an individual borrower will vary upon a number of factors specific to the lender and the borrower, interest rates can be tracked in aggregate. When interest rates are high, this can have a number of wide-ranging effects.

Lower Demand for Loans

  • The most immediate effect of high interest rates is a drop in the demand for loans. When interest rates are higher, it means that borrowers will be paying more to take out loans, as they will be paying more back in interest payments. Therefore, when the interest rate rises, many borrowers will hold off on taking out loans until the price becomes less expensive.

Drop In House-Buying

  • A rise in interest rates affects many segments of the economy. One of the most directly affected is the home-buying and construction industries. This is because to build and buy homes, people are generally required to take out a loan. If the interest rate is high, fewer loans will be taken out. This will lead to a drop in the purchase and construction of homes, as people put off their home-buying.

Economic Slowdown

  • In addition to putting the brakes on home sales, higher interest rates can affect businesses that are considering expansion. When the interest rate is low, it makes sense for businesses to take out money to grow, as they will not have to pay much in interest. This can lead to further economic growth. However, when rates are high, businesses may not grow. This can lead to stagnant economic growth or even a recession.

Lower Inflation

  • Interest rates and inflation are often closely linked. As interest rates drop, lending can increase and the economy can flourish. This can often lead to a spiral of higher wages and higher prices. By contrast, when interest rates are high and the economy stagnates, inflation may slow down as prices rise only a little. Some economies may even experience deflation, which can be problematic as businesses must cut prices and wages.

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