Posted By: Dr. Frugal in Saving on 08/29/2007 at 07:05:02
Wren interest rates are low, people are more likely to buy on credit, which increases consumer spending. Consumer spending accounts for about two-thirds of our economy, so when people feel good about spending, the economy chugs along. Businesses expand and hire more people. Wages rise as employers compete for fewer workers, which puts pressure on corporate profits. Companies have to raise prices to compensate for their extra costs. If the economy heats up too fast, it leads to inflation, which can have a bad effect on the economy.
The government raises interest rates to control inflation and cool off an over-heated economy. This makes it more expensive to borrow, and consumers cut back their spending. Demand for products drop, pressure on wages eases, and companies decrease payrolls. Higher interest rates have a braking effect on the economy and can help keep inflation under control. The danger is that if the government raises interest rates too fast or too high, they may dampen the economy into a recession. Finding the right balance is a delicate process. All the more reason to keep some money set aside for a rainy day.
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