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How Does the Health of the Economy Affect Interest Rates? »

How Do Interest Rates Affect the Economy?

Lower interest rates make it easier for people to borrow in order to buy cars and homes. Purchases of homes, in turn, increase the demand for other items, such as furniture and appliances, thus providing an additional boost to the economy.
Lower interest rates mean that consumers spend less on interest costs, leaving them with more of their income to spend on goods and services. Lower interest rates make it easier for farmers, manufacturers, and other businesses to borrow to invest in equipment, inventories, and buildings. Also, the returns that investments will produce in future years are worth more today when rates are low than when rates are high. That gives business more of an incentive to invest when rates are low. Increased business investment, in turn, makes the economy grow faster, as productivity, or output per worker, increases faster. Interest rates do not seem to affect the amount that people save. That’s because higher interest rates have two conflicting effects on how much people save. First, the higher return that savings can earn gives people an incentive to save more. Second, however, the higher return makes savers feel richer, so they may spend more, rather than save more.

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