- Cecilia Barria
- BBC News World
1 hour
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With rampant inflation sweeping the globe, interest rates are on the rise.
To try to control the rapid increase in inflation, countries in different regions of the planet have been increasing the cost of money, which in practice translates into more expensive credit.
So, with very high rates, nobody wants to get into debt.
This situation affects companies that need to borrow money to carry out their investments, governments that need to finance public spending, and also affects people who require loans to buy a house, a car or finance an unforeseen expense.
Who makes the decision to raise or lower rates? The central bank of each country that, in general, works independently of the government in power.
Since inflation began to climb rapidly, first due to the effects of the covid-19 pandemic and then due to the war in Ukraine, the debate has centered around how fast and how deep the authorities must go to lower it.
In the United States, for example, the Federal Reserve System (informally known as the Fed), equivalent to the central bank, has been harshly criticized for having “taken too long” to start raising rates.
Things calmed down when in March he raised interest rates for the first time since the start of the pandemic, giving the first sign that the “era of cheap money”, with rates close to zero, was coming to an end.
And this Wednesday he raised the rates by half a point, leaving them in a range between 0.75% and 1%, when the country is mired in runaway inflation that has climbed to 8.5%, the highest level in the last 40 years.
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In the United States, the “era of cheap money” is over.
“Inflation is too high and we understand the difficulties that’s causing,” said Fed Chairman Jerome Powell. “And we’re moving decisively to bring it down.”
Of all the effects that an increase in interest rates can have, the most obvious is that it manages to control the increase in the cost of living.
“When the rate rises, in theory, demand should moderate and that generates less pressure on inflation,” Elijah Oliveros-Rosen, senior economist at the Latin America Global Economics & Research division of the consulting firm S&P Global, tells BBC Mundo. Ratings.
“The subidrate is a global trend”he adds, but warns that it has advanced at different rates in different parts of the world.
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“It started last year in Latin America. Then the United States followed, then the United Kingdom, and later Asia. Now it’s up to the European Central Bank,” says the economist.
These are some of the most important consequences generated by the increase in interest rates.
1. It is more expensive to borrow money
Commercial banks will charge you higher interest for lending you money.
Even if you don’t directly request a loan, but use the credit card, it works with a variable rate.
If you don’t pay it on time, “the penalty” will come through the charging of much higher interest.
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In short, since it is more expensive to borrow, your purchasing power is reduced.
On the other hand, companies use credit a lot to invest, in such a way that the increase in rates does not encourage investment.
And it makes the cost of fiscal financing more expensive for countries.
That means that when they issue a bond, they have to offer a higher interest rate to convince lenders that they are doing a good deal by providing resources.
Basically, the government has to pay investors more.
“That is why capital moves to countries that offer higher interest rates in search of better returns,” Pablo Gutiérrez, a researcher at the University of British Columbia, tells BBC Mundo.
In the same way that the increase in rates discourages consumption, encourages saving.
Saving becomes more attractive because it increases profitability, that is, it is more profitable to have money in the bank.
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“Raising the interest rate is like a way to chill the economy”Gutierrez says.
At the end of the day, he says, “there is less money in the economy and, therefore, there are less inflationary pressures.”
But raising rates is not a magic bullet, which explains why it works better in some countries than in others.
3. Can affect al economic growth
The global wave of rising interest rates “generates a moderation effect for economic growth,” explains José Luis de la Cruz, director of the Institute for Industrial Development and Economic Growth (IDIC) of Mexico.
The increase in rates affects the investment capacity of companies and the demand for consumer loans in a rather complicated context at the global level.
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A context where there is a precarious recovery of the European economy, a slight slowdown in some areas of the US and difficulties from China, both due to the lower economic growth of the Asian giant, as well as the problems caused by covid-19 says the economist.
“The world is headed for a transition from a low-growth, high-inflation economy to an economy that will be able to contain inflationary pressures in the next two or three years, but with certain limitations to growth“explains de la Cruz in dialogue with BBC Mundo.
In that sense, “it is bad news for a world that has just emerged from one of the worst recessions in the last ninety years and now finds itself once once more in a restrictive economic scenario due to inflationary pressure, the increase in interest rates and low growth.
Anyway, So like rising interest rates it can slow down growth, it can also lower inflation.
What is clear is that finding the balance in monetary policy decisions according to the needs of each country is not an easy task.
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