Interest Rate Manipulations and Their Impact on a Common Person

Manipulation of interest rate is the practice of increasing or decreasing the interest rates to spur or slow down the economic growth in a country. This power of changing the interest rate lies upon the country’s central banks. Manipulating interest rates has a direct effect on inflation rates. Inflation is the decreasing power of money over time, and its rate may vary depending upon the demand and supply in the country. 

The value of money changes over time—inflation results in a change in the value of one unit of currency. One unit of currency today has more value than tomorrow, which directly results from inflation. With a high inflation rate, the purchasing power of a man decreases and vice versa. Interest rates are manipulated in various forms, and they all have a significant impact on the common man. 

Why does the interest rate change? 

The interest rate is a tool that helps in achieving economic goals and objectives according to the monetary policy of a particular economy. It is also known as the cost of borrowing money, due to which it keeps on changing. A country needs to maintain a neutral interest rate because constant interest rate fluctuation might result in an unstable economy.  

How are interest rates manipulated? 

The lower the interest rate, the higher the borrowing power. This means more money circulating in an economy, and people would have more purchasing power. But the ultimate result of this is a decrease in savings. The downside of lowered interest rates is an increase in inflation. This is because the goods and services are finite in production, and more resources are required for long-term goals. A high inflation rate is not necessarily a good sign for an economy. The trick to maintaining an excellent economic system lies in balancing the inflation rates. 

The usual ways interest rates are manipulated are:

1. Open Market Operations: This involves the central banks buying or selling treasury bonds openly in the market. Treasury bonds have an important role in the money supply in an economy. Buying the bonds means the central banks let out money to the general public and sell the results of the bond in money inflow to the central banks. When the bonds are bought, prices increase due to decreased interest rates. 
2. Reserve requirements: Every bank has some reserve safeguarded. The central banks give the minimum amount of reserves to be maintained to the commercial banks. By tweaking the reserve ratio, the central bank can easily manipulate the borrowing tendency of people. The greater the reserve ratio, the lesser the interest rate, and the lesser the reserve ratio, the higher the interest rate. This is usually manipulated through repo rates and reverse repo rates. Repo rate is the interest set by the central banks when central banks borrow money, and reverse repo rate is the commercial bank’s interest rate when the central bank borrows in case of excess money. 
3. Demand requirements: In an economy, demand and supply play an important role. Demand, simply put, means what a person can buy or a person’s purchasing power. When the demand is high, people tend to borrow money more, manipulating interest rates. 
4. Influencing market perceptions: The central bank very rarely influences the market into believing something or giving out a statement that might affect interest rates. The statements could be something like, “there is a possibility of an increase in inflation”, which convinces the market that there will be an increase in interest rates. 

The four factors that influence interest rates are:

1. Supply and demand: Increase in demand leads to an increase in interest rates. This is because when there is a high demand in the economy, credit power is increased, and ultimately the central banks increase the interest rates. But increase in the supply of credit decreases interest rates and vice versa. This is because when credit is high, there has to be a lower interest rate so that people can borrow more. 
2. Inflation: Inflation is one of the most common reasons why there is a fluctuation in interest rates. The higher the rate of inflation, the more likely interest rates will rise. This happens because lenders will demand higher interest rates in order to compensate for the eventual loss of buying power of the money they are paid.
3. Government: the government often has a say in how the interest rates should be altered through monetary policies. According to their goals, the central banks then manipulate the interest rates through the above-mentioned methods. 
4. Global interest rates and foreign exchange rates: One of the effects of globalisation is the increase in interest rates with respect to the interest rates of other economies. To attract a global market, an economy’s interest rate has to change through global standard perspectives. 

How does interest rate affect a common man? 

Interest rates affect a lot of people in a country. It is often assumed that interest rates only affect business institutions or shareholders, and stakeholders. While it is halfway true, investors do have to calculate the interest rate precisely and whether or not their investment would result in profits. However, a change in interest rate also affects the commoner. 

• In cases of high-interest rates, people who have savings profit as the interest is converted to monetary value and added to the savings. 
• Borrowers can avail of loans while there is a low-interest rate. This is a positive impact of low-interest rates. 
• Low-interest rates made borrowing for mortgages very easy. Buying homes and building construction has had phenomenal growth in recent years. Real estate agencies bloom with a low-interest rate in the market. 
• Interest rates affect a commoner through linkages. It simply means that it becomes challenging to liquidate assets when there is an increase in interest rates. On the other hand, low-interest rates provide more job employment and opportunities because of increased investments and fund transfers. 
• After real estate agencies, the next highly impacted sector would be the capital formation institutions—the more the interest rate, the lesser the capital formation and vice versa. 
• It affects a company’s manufacturing and selling capacity because most companies rely on funds from other institutions. Change in interest rate influences the sales and production units. 
• The value of currency increases when there is an increase in interest rates. This can impact everyone in the economy. High currency value results in increased trade opportunities and foreign investments. However, it reduces the purchasing power of an individual. 
• It affects people who have borrowed loans for a long time. When interest value changes for an economy, it also changes for the loans. If the interest rate now is 2% and a person has availed a loan for 5 years, when the interest rate changes, the person has to adhere to the change in interest value and pay accordingly. It cannot be 2% throughout 5 years. 

Conclusion

Manipulation of interest rates has a great role in stabilising an economy. It controls the money supply across a nation, and the central banks hold this power. The central banks regulate the interest rates through various studies and prevailing economic conditions. It is very difficult for an economy to procure a stable interest rate for a more extended period because there are a lot of external factors that directly affect the interest rates.