Interest Rates Essay

1355 words - 5 pages

1.0 IntroductionInterest rates can be described as the amount of money charged as a fee for lending money or the price of borrowing money (Barney, 2006). If interest rates rise, you will have a larger mortgage and other debts; it is likely that you will have to reduce your spending. Savers will be encouraged to save more and spend less. A fall in interest rates will have the opposite effect.Rates are now at their highest level since 1996 after 11 consecutive increases (Mes, 2008). With these high we can expect inflation to be high and unemployment low.2.0 CausesThere are many reasons why there are interest rates rise, but they are mainly because of the increased spending and increased aggregate demand within the Australian economy. The monetary and fiscal policies are used to try and slow spending and to promote saving.Inflation is defined as the change in the level of price (Barney, 2006). High inflation within the economy causes interest rates to rise as high inflation reduces the purchasing power of money. One of the most common methods of measuring inflation is the Consumer Price Index or "CPI". The Consumer Price index is a measurement in the change in price of an average “shopping basket” of consumer goods for a country, within a month. This basket is then compared to the price change from the “base year” (A year that is selected where there are no dramatic increases or decreases in price), which gives it an index number to measure monthly increases or decreases in inflation (Barney, 2006).Inflation has changed dramatically overtime and it is obvious why inflation and interest rates are so high now. Looking back, the average price for a kilo of potatoes were 75 cent now they are around the $4 mark, the same with a loaf of sliced bread, it used to be around $1.44 and now can be bought for around $4. This is not only these household goods, it is everything, inflation has nearly doubled over 15 years and as a result of this we are experiencing high interest rates.The Reserve Bank of Australia (RBA) is generally aiming at an inflation target of around 2% (Russel 2008). In recent months the Australian economy has touched the 4% barrier (appendix 2), although aggregate demand and spending in the economy has continued to increase, therefore the interest rates have continued to rise. In recent times, the CPI report for March showed an average annual rate of 4.25% compared to 3.6% previously (RBA, 2008). The last time underlying inflation was this high was 1991. As inflation continues to rise, interest rates will as well.Interest rates change because of the supply of funds available from lenders and the demand from borrowers. Looking at the mortgage market, when many people are borrowing money to buy houses, banks need to have the funds available to lend. They can get these from their own depositors; they borrow from savings accounts, various international businesses and more. For example, banks pay 6% interest on five year...

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