Economic realities are a huge part of what makes living in a location a great or bad experience. This is why pertinent government institutions are usually very intentional about influencing them. By and large, economic realities are influenced by a large number of factors, including:
- Global economic conditions
- Demographic trends
- Technological innovations
- Current market dynamics
- Natural resources & environmental factors
- Institutional framework
- Current market conditions
- Cultural & social factors
- Policy uncertainty
- Macroeconomic policy
All of the above-listed and several others influence economic realities. However, some are more influential than others. Key policy rate (also known as key interest rate) is an example of a macroeconomic policy and is high on the list of things that determine current economic realities. It is perhaps the most influential factor.
This is why it has to be well understood by all. Fortunately, this article sheds some light on this subject. So, read on to find out more.
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Key Policy Rate
It is otherwise known as the key interest rate. It is an interest rate policy set by the central banking authority of a country. It is meant to determine the order of credit activities in the credit market. This is by placing a benchmark on the extent to which borrowers can be charged in the credit market.
This is not to say that lenders or creditors in the credit market do not have any power to determine how much they charge borrowers. However, it places caps on how much lenders and creditors can charge in the financial system.
How Key Policy Rate Affects Economic Realities
Many fiscal and monetary policies are instituted and overseen by every nation’s central banking authority. There are even several macroeconomic policies besides the key policy/interest rate being discussed here.
Be that as it may, the fact that the key policy rate is one of the most crucial of them all cannot be overemphasized. On the whole, this is because it affects the general economic narrative.
For example, it can cause a massive shortage of monetary resources, leading to general financial hardship. On the other hand, it can cause inflation and currency devaluation.
In light of these possibilities and more, serious work has to go into deciding key policy rates at a given time. Failure to do this can be highly disadvantageous for any country. In the spirit of helping you understand how important this macroeconomic policy is, here are some ways it could affect/determine economic realities:
Investment & Capital Expenditure
More often than not, corporate establishments are more stimulated to borrow during periods when interest rates are low. The reason is not far-fetched as borrowing costs are reduced.
As a result, these establishments, including Small & Medium Scale Enterprises (SMEs) are encouraged to borrow for expansive purposes. For example, these establishments can go on to invest in new technology, infrastructure, and equipment.
By and large, it could be a period when these establishments end up being more efficient, productive, as well as competitive. This is one of the ways that key policy rates can drive economic growth.
Furthermore, the fact that there is enough cash in the system means that these establishments can afford to hire more hands. The effect on employment rate is another way this crucial macroeconomic policy can drive economic growth.
Consumer Spending
The aforementioned point stresses how low interest rates can help corporate establishments. Well, it also affects consumers as well.
The reason is that low borrowing costs would be tempting for prospective borrowers. You can check besterefinansiering.no/styringsrente/ for more information on this. By and large, there is likely to be increased borrowing in the credit market.
Some (and possibly a lot) of the borrowed funds would then go into big-ticket purchases. This includes buying home appliances, automobiles, and more. This could drive up the revenue of businesses in this line of work and help them scale up.
Housing Market
Home ownership is a big deal for many people and this is quite understood. However, not everyone can foot the entire cost of owning a real estate property at once. This is because of the capital-intensive nature of such purchases.
Fortunately, there are mortgage arrangements but key policy rate is an influencing factor. For starters, it determines how many people would be able to access this type of credit line. Furthermore, it determines how many people would be even willing to access it.
In situations when the rate is low, people are usually encouraged to access these loans. This in turn affects patronage in the real estate market as more people will be capably interested in properties.
The cycle does not end there as increased patronage in this market usually means that real estate assets experience a surge in value. Homeowners and property sellers usually benefit from this as they stand an increased chance of earning more when assets are sold, leased, or even rented.
The reverse is the case when key policy rates are on the high side. This is because fewer people will be able and willing to access mortgage credit lines. This in turn impacts the housing market and how much homeowners and sellers can make from the market.
Savings & Investment Decision
There will always be losers and winners, regardless of the outcome of a key policy rate. Speaking of losers in situations when this rate is low, people who bank on fixed investment and savings schemes are on this list. This is because the low rate limits their dividend.
As a result, some of these people would be unsatisfied and willing to go all out. This is by considering investments that promise higher returns. Usually, a lot of what these people consider are highly volatile ventures. Prime examples include investments in stocks, precious metals, bonds, and even real estate.
Cost of Servicing Debt
Borrowers can either be subjected to either of two kinds of interest rates, depending on the terms and conditions of their loan agreement. It is either the interest accrued on their loan is fixed or variable.
As the name suggests, fixed interest rates do not change. This is except for conditions of violation such as late payment or even early payment.
On the other hand, variable interest rates can change and they are largely determined by key policy rates. Debt servicing is easier when this rate is low. This is because the interest that accrues will be low, as well.
However, debt servicing is more difficult when this rate is high. This is because the interest that accrues will consequently be high. So, this is how this fixed rate by the central banking authority of a country determines how easy or difficult debt servicing will be.
Inflation/Deflation
Inflation is when a currency’s purchasing power is weakened. Deflation on the other hand is when a currency’s purchasing power is strengthened.
Having made this clear, you should know that this crucial macroeconomic policy is capable of causing inflation or deflation. For the most part, low rates lead to inflation, while high rates lead to deflation.
Conclusion
There are economic patterns and actions that affect everyone. This is regardless of whether or not they are understood.
The concept of key policy (interest) rate is certainly one such. This is why it has to be well understood. Furthermore, having a good understanding of it can even help with financial planning. For example, it can help with timely investment.
