Question

The Federal Reserve has recently started to adjust interest rates higher after maintaining lower rates in response to the 2008 recession. What is the economic significance of this change? What will the impact be on the business environment?

Please do not copy and paste answer, thank you.

Answer 1

It is widely known that the interest rates and the economy growth are inversely proportional to each other. Whenever the interest rates are kept low, there is a scope for economic growth and whenever the interest rates are kept higher, the economic growth stabilises and growth rate is less.

During the 2008 criris, the economy had taken a hit and widespread job losses were seen. hence to boost the economy and to spur activity in the economy, the FED had resorted to lowering the interest rates. With low interest rates around, the loans provided by the banks were cheaper and there were sufficient liquidity in the economy. In short more money was available at the hands of the people and corporates to spend and spur the economy after the 2008 crisis.

Hwever, every economic measures has its own flip side too. If too much money is available in the economy for spending, it also leads to a situation where there is high inflation. A high inflation (Cost of money or real value of growth of money) is not good for an economy as it stalls the economy growth rate. It is main responsibility of the Fed to keep the inflation rate in check and within the permissible levels. Once the inflation rate is nearing the threshild limits, the Fed would resort to increasing the interest rates. Once the interest rates are increased, the loans by banks become costlier and the excess liquidity in the economy is sucked off by the Fed. hence too little money is available in the economy for spending and naturally as a consequence, the inflation rate would come down. This playing with the interest rates by the Fed is one of the major functions of the Fed.

Now since the interest rates are higher, borrowing cost becomes dearer and companies start managing their finances better and the cost of finished goods in the market and becomes costlier as these companies pass on their increased cost of borrowing on to the final consumer. One could see increased cost of products during this period.   

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