Money and Interest Rates

Money and Interest Rates

The Functions of Money

  • Offers a means of exchange: Making trade possible, money is used to sell and purchase goods.
  • Acts as a store of value: Money can be saved and used in the future.
  • Provides a standard of deferred payment: Used in credit transactions for past dues and future payments.
  • Unit of account: Utilized to measure the value in economic transactions.

Monetary Policy

  • Monetary Policy is carried out by Central Banks to control inflation through interest rate levels.
  • Inflation targeting ensures inflation doesn’t affect the economy adversely.
  • Raising interest rates can contain inflation but may slow down economic growth.
  • Lowering interest rates can stimulate economic growth but runs the risk of increasing inflation.

Interest Rates and Investment

  • Higher interest rates increase the cost of borrowing, discouraging firms from investing.
  • Lower interest rates make borrowing cheaper, encouraging economic investments.
  • Interest rates also affect consumer spending. When rates are high, consumers are likely to save rather than spend.

The Money Market

  • The money market is where short-term borrowings are managed.
  • Supply of money is controlled by the central bank.
  • When the demand for money is high, interest rates are likely to rise.
  • If demand for money is low, interest rates are likely to fall.

Inflation and Interest Rates

  • Inflation erodes the value of money, which can be negative for savers.
  • Central banks use interest rates as a tool to control inflation.
  • High inflation usually leads to high interest rates.

Money Supply and Economic Activity

  • An increase in money supply can stimulate economic activity.
  • However, too much money supply can lead to inflation.
  • Conversely, reducing money supply can cause a recession.

Role of Banks

  • Banks play a crucial role in the money market through their lending and investing activities.
  • They also help in the implementation of monetary policies by adjusting their lending rates based on the interest rate set by the central bank.

Remember, the relationship between money, inflation and interest rates is complex and influenced by a variety of factors. Understanding these concepts and how they interlink is fundamental in making meaningful economic decisions and predictions.