Changes in interest rates can have a big impact on an economy. Miscalculation in determining the interest rate, the result is bad!
What exactly is the interest rate and who has the authority to determine it?
Interest rates are a very important 'tool' in setting monetary policy that aims to control the economic stability of a country.
It is controlled by the central bank in every country around the world.
This set interest rate affects the loan rate. When interest rates are high, loans will become more expensive and reduce consumers' desire to spend.
The central bank will determine interest rates that are appropriate to the current economic situation at that time so that the economy remains at its best.
The Role of Interest Rates in Controlling Inflation
The central bank has set an inflation target that is mostly between 2% and 3%. This is the main indicator for the central bank to change interest rates to match current inflation.
When inflation is too high beyond the target level, the central bank will act to raise interest rates which will make loan rates more expensive and encourage people to spend less.
Why is it necessary to make a loan so expensive?
It is intended to reduce the supply of money in the economy while helping to control inflation that is too high, which is the rate of increase in the price of goods and services so that it returns to a stable level.
Similarly, when inflation falls below the target level, for example 1.0%, the central bank will lower interest rates so that many people will be more willing to spend.
The increasing money supply in the economy will make the inflation rate rise again to reach a stable level.
How Is Inflation Affected by Interest Rates?
Inflation occurs when there is an excess of money that causes everyone to be able to spend causing prices to rise.
By raising interest rates, the excess supply of money in the economy can be reduced, thereby controlling excess demand and slowing inflation.
As interest on loans increases, consumers and businesses will reduce spending. This reduction in demand helps cool the economy and prevents prices from rising too quickly.
For businesses, higher interest rates mean the cost of starting a new business increases. This can cause a slowdown in business expansion and hiring, which in turn slows economic activity and inflation.
The central bank tries to balance interest rates to support economic growth while controlling inflation at the best possible level so that the public is not burdened.
If interest rates are too high, it risks slowing economic growth and may increase unemployment.
But interest rates that are too low can lead to excessive borrowing and spending, pushing inflation to uncontrollable levels.
In conclusion, the central bank needs to be wise in setting a strategy in setting appropriate interest rates so that the country's economy continues to remain stable.
