I recently asked on RG if low or high interest rates were better for a national economy. Most people said that lower interest rates are better for economic development and growth.
But can interest rates be too low?
When interest rates are extremely low, can't it cause more problems than benefits?
What are the negative effects of very low interest rates?
Yes, too low, money becomes an asset without value, worst with negative value. The theory wants that type of asset wasted. Keynes explain the phenomenon of liquidity trap.
Interest rates that are "too low" or unreasonably low may encourage risky behavior because the cost to finance is cheaper than maybe it should be and might allow those not normally able to afford purchases, the ability to make those purchases. Asset bubbles in housing or stocks are two common outcomes. Would you buy a house with 20% interest rates? Maybe not, but you would be more likely to do so with 5% financing.
it depends on the status of economy if it is overheated it must be low interest using expansionary money policy
INTEREST RATE is generally announce by the Central bank in the country. the Central Bank generally announce the interest rate based on the country's current economic condition. Therefore, interest rate at any given time cannot be too low or too high. If the central bank is working correctly, whatever rate may be at any given point is an appropriate rate reflecting the current condition of the economy.
TOO LOW OR TOO HIGH is a judgment people made on the basis of facts which are not consistent with the decision makers announcing the interest rate, i.e. the Central Bank. To say that the Central Bank of a country is not in-keeping with the current condition of the economy- - - is too strong an assertion to make. Since one of many functions of the Central bank is to monitor and update interest rate, failing to do so is failing in discharging that duty for the country.
People have varying degrees of risk-taking. Some are building equity and accepted risk. There are people with patrimony made, and who want to keep it, not wanting any risk.
On this subject of risk aversion, Jorge Paulo Lemann, the most successful Brazilian businessman, said he feels like a "terrified dinosaur" in the face of innovations that are transforming the business world. I am sure that a few years ago he would be laughing at economic environment problems.
Lowering rates makes borrowing money cheaper. This encourages consumer and business spending and investment and can boost asset prices. Lowering rates, however, can also lead to problems such as inflation and liquidity traps, which undermine the effectiveness of low rates.
There are many wealthy people whose concern is more with maintaining their wealth than growing it. For such a risk profile, low interest rates are no problem.
The point is not in the height or lowness of interest rates, but in the spread between active and passive rates.
Currently this gap is very high and extremely negative for economic development (which in fact is depressed).
Lowering rates makes borrowing money cheaper. This encourages consumer and business spending and investment and can boost asset prices. Lowering rates, however, can also lead to problems such as inflation and liquidity traps, which undermine the effectiveness of low rates.
When the interest rate is too low, concerned about depositors, however, may encourage the Islamic Economy because taking interest is forbidden on loans for consumption and productive purposes.