INTEREST RATE CHANGES AND ITS IMPACT

The working of transmission mechanism of the monetary policy means the way as per which changes in the interest rate affect the spending and savings of large number of households as well as entrepreneurs in an economy.

The effect of changes in the rate of interest are quite complex as well as the time gap between its announcement and final impact on economy is greater than expected. Interest rate changes works through various ways :

• Effect of interest rate changes on households: Increase in rate of interest (ROI) increases the cost of mortgage and reduces the demand for most type of housing on the other hand fall in ROI stimulate higher market demand.
• Credit demand : A lower ROI induces household to distribute there saving in various forms of credit and increases their demand for consumer durables
• It redistributes income for savers and borrowers: A fall in ROI re distributes income away from lenders towards with variable rate loan. Changes in ROI also effects the consumer confidence as those that are confident about their financial position will be willing to enter into large scale purchase. High ROI has a negative effect on consumer confidence.
• Effect of Interest rate changes on business: (a) investment and stock building- firms consider ROI while making any sorts of investment. A fall in ROI should increase business confidence and raise the level of investment by firms.                                                       (b) sterling exchange rates- lower ROI might cause depreciation of exchange rate and boost demand for domestic goods internationally. A rise in growth of exports works as an injection in the economy and increases aggregate demand and also the factor incomes. This leads to a new and higher level of equilibrium of national income and multiplier effect.

Click here for government certification in Accounting, Banking & Finance