It’s the simplest of all policies. If a central banker wishes to stimulate an economy – they cut the central bank base interest rate. If they wish to moderate it – they raise the rate. The classical theory being that manipulating the rate alters the cost of credit and thus encourages/hampers individuals and firms spending incentives accordingly.
As we can see from the charts above, developed economies have maintained persistently low interest rates ever since 2008 and the Global Financial Crisis (and in Japan’s case, a lot longer…). The central banks have been attempting to gee up economies with cheap credit, exactly as the theory advises. However, as has been seen in the years subsequent – economic growth in each of the same economies has been relatively anaemic in spite of the historically low interest rates.
Thus this post will investigate the channels that interest rates are supposed to affect the economy – looking how it is supposed to affect both individuals and firms. Although it is an elementary discussion, its apparent ineffectiveness in recent years highlights that an assessment is a worthy exercise.