Question

With a minimum of 5 journal article examine the determinants of interest rate in developed and developing economies.

Answer 1

Interest rate is the price demanded by the lender from the borrower for the use of borrowed money.

Factors affecting the Interests Rate

Interest rates are typically determined by the supply of and demand for money in the economy. If at any given interest rate, the demand for funds is higher than supply of funds, interest rates tend to rise and vice versa.

Monetary Policy: The central bank of a country controls money supply in the economy through its monetary policy. In India, the RBI’s monetary policy primarily aims at price stability and economic growth. If the RBI loosens the monetary policy (i.e., expands money supply or liquidity in the economy), interest rates tend to get reduced and economic growth gets spurred; at the same time, it leads to higher inflation

Growth in the economy – If the economic growth of an economy picks up momentum, then the demand for money tends to go up, putting upward pressure on interest rates.

Inflation: Inflation is a rise in the general price level of goods and services in an economy over a period of time. When the price level rises, each unit of currency can buy fewer goods and services than before, implying a reduction in the purchasing power of the currency. So, people with surplus funds demand higher interest rates, as they want to protect the returns of their investment against the adverse impact of higher inflation.with rising inflation, interest rates tend to rise. The opposite happens when inflation declines.

Global liquidity: If global liquidity is high, then there is a strong chance that the domestic liquidity of any country will also be high, which would put a downward pressure on interest rates.

Uncertainty: If the future of economic growth is unpredictable, the lenders tend to cut down on their lending or demand higher interest rates from individuals or companies borrowing from them as compensation for the higher default risks that arise at the time of uncertainties or do both. Thus, interest rates generally tend to rise at times of uncertainty.

Political short-term gain: Lowering interest rates can give the economy a short-run boost. Under normal conditions, most economists think a cut in interest rates will only give a short term gain in economic activity that will soon be offset by inflation

Deffered consumption: When money is loaned the lender delays spending the money on consumption goods. Since according to time preference theory people prefer goods now to goods later, in a free market there will be a positive interest rate