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Interest and Inflation

Interest rates fluctuate constantly. They are controlled by supply and demand and other economic indicators. Other factors that help determine an interest rate include the length of the loan and any collateral used to secure the loan in the event the borrower cannot repay the loan. Low interest rates can stimulate the economy; consumers are attracted to low interest rates on consumer goods, cars, and houses and may spend more when interest rates are low. High interest rates usually have the opposite effect. Consumers are reluctant or unable to spend money, or spend as much money, when interest rates climb.

The Federal Reserve Board of Governors, part of the Federal Reserve System, sets a benchmark interest rate known as the prime rate. The Federal Reserve, the central bank of the United States, was founded in 1913 to help regulate the country’s money supply. The goals of the Federal Reserve Board are to control inflation, maintain stable prices, and promote maximum employment and output of products for a favorable economy. This is done, in part, by raising and lowering interest rates. Low interest rates spur the economy but may lead to inflation, which harms the economy in the long term. The Federal Reserve Board looks at a range of economic indicators to help it determine what its policies should be and whether to raise, lower, or maintain the prime interest rate.

Any national bank must be a member of the Federal Reserve System and is governed by its fiscal policies. State banks may belong to the Federal Reserve System but are not required to; state agencies regulate state banks. Savings and loans, which are similar to banks in many ways, are regulated at the federal level by the Federal Home Loan Banks System. However, regardless of the Federal Reserve’s jurisdiction over any financial entity, the prime interest rate is often the arbiter of interest rates.

Interest rates have a profound effect on the national and worldwide economies and are affected by economic changes as well. Economists like Adam Smith and David Ricardo theorized that interest rates are the key in balancing investments with savings. Marxist economists believe that interest benefits only capitalists, leaving other classes exploited, since no service is rendered to those who pay interest. Other economic theorists have deemed interest as a sort of reward for those who save, rather than spend, their money, since bank accounts and other investment vehicles typically pay interest to account holders.

Inside Interest and Inflation