How will zero interest rates affect the economy?

In Financing by Tim DieselLeave a Comment

Zero interest rates are a big part of the news cycle these days. This is a fiscal response to the spread and ongoing outbreak of the coronavirus as it makes its way around the globe and into every state in the union. With the slashing of interest rates comes a number of changes, which we’ll explore below.

The Federal Reserve and Interest Rates

The Federal Reserve System first came into existence back in the early part of the twentieth century, being established in December of 1913. It was put into place as the result of a number of financial panics in order to establish a system of centralized control.
ZIRP is a method of stimulating growth while keeping interest rates close to zero. Under this policy, the governing central bank can no longer reduce interest rates, rendering conventional monetary policy ineffective. As a result, unconventional monetary policy such as quantitative easing is used to increase the monetary base. However, as seen in the Eurozone, over-extending a zero interest rate policy can also result in negative interest rates. Thus, many economists have challenged the value of zero interest rate policies, pointing to liquidity traps amongst several other pitfalls. —Investopedia
From that time on, the Federal Reserve has set the interest rates. These being the cost of money lent to banking and other financial institutions. (It’s important to note that the interest rate set by the Federal Reserve is not the rate directly accessible by the consumer.) Meaning that banks, credit unions, and other financial institutions can then lend money to the public at a different rate.

How will Zero Interest Rates Affect the Economy?

So, just how does a zero interest rate affect the overall economy? Well, it has an impact on many different areas of life, like the following:
  • Mortgages. Since banks and credit unions can borrow money at a lower cost, those institutions are expected to pass on the savings to consumers, particularly home buyers and homeowners who are refinancing. (This is equally applicable to commercial real estate purchases and commercial mortgage refinancing.) Such a dynamic is intended to entice home buyers, homeowners refinancing, and commercial real estate investors into taking action.
  • Credit cards. As with mortgages, including refinancing, credit card interest rates may also fall, but will probably lag behind the Federal Reserve’s cuts. Because the rates have come down, credit card companies should begin to offer lower rates to retain existing customers and attract new customers.
  • Auto loans. Although most debt instruments follow changing interest rates, auto loans in recent years have not reacted predictably. However, with such a large change down to zero, auto loan companies could follow other lenders and offer better terms.
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