lower interest rates impact us aside from lower mortgage and lower fixed
deposit rates. Having studied economics in my junior colleague for 2 years and
another ½ year in university, I seems to know, but stumble to explain convincingly. Hence I decide to write a post on this topic.
will know that Aggregate demand is the demand for the gross domestic product
(GDP) of a country, and is represented by below formula. In general AD
represents the GDP of the country without taking into account inflation.
+ I + G + (X-M)
- Lower mortgage -> spur property
purchase -> increase C
- Reduce incentive to save -> increase
- Cheaper borrowing cost for firms
-> Aggressive expansion -> increase I
Lower R leads to Higher (X-M)
- Less attractive to save in the country
as better rates overseas -> less demand for local currency -> value of
local currency reduce -> Exchange rate depreciates
- Export becomes cheaper relative to
other currencies -> increase X
- Import becomes expensive relative
to own currency -> reduce M
- Increase (X-M)
In theory, with the
increase in C&I and (X-M), AD will also rise, thereby increasing the real
GDP of the country. However it is not necessarily true, especially in times of
- Overall export demand will fall
- Rate of interests may be low, but
bank is cautious of lending
- Consumer confidence will also be
low leading to lowering spending, despite the low borrowing rates.
- If the country is experiencing
deflation, even if rate of interest is low, the effective real interest is
- Time lag. E.g. most mortgage loan
has 2 years fixed period. The lower interest rate will only benefit you after
your existing mortgage loan expired. The same applies to company with loans are
already hedged over a period of time.
aggregate supply, it determines the current level of prices and the employment
of resources (real GDP or real output).
increases, the curve it shifts to the right. Real output will increase. But price
level will also increase i.e. inflation.
to imagine that increase spending in consumer, investment and export expenditure
will drive the prices of good and services up.
/ Borrowers with lower mortgage / borrowing cost
- Investors of companies. With lower interest rates, companies will have access to cheaper financing to accelerate their
- Countries with lower proportion of saver.
Example US and UK with high level of mortgage debts. Singapore, China, Hong
Kong, Thailand and Malaysia also have high build up mortgage debt.
external public debt as a country. China while having high debt is net
trillions of debt (106% of GDP), follow by UK with ~US$9.6 trillions (406% of
GDP). Refer to wiki here for list of countries by external
Especially retirees who live on their savings in the bank. With lower interest
rate, leading to inflation, their real disposable income will be greatly
- Countries with higher proportion of
- EU countries tend to rent more than taking mortgage loan, hence its less beneficial for them. For example, Germany’s
homeownership in 2013 is only 43%. Singapore’s homeownership is ~90%.
rates will devaluate local currency. In turn, exports are more competitive and
export demand will increase i.e. X > M, which means current account will
is relatively elastic. Not in times of global recession.
interest rates encourage spending. In doing so, spending on imports increase
and current account will deteriorate if this is true.
in foreign currency, the devaluation of its currency will resulted in more debts
in foreign currency. E.g. the depreciation of Rupiah against USD is not doing
Indonesia economy any good, because she has a debt of 26 trillions in USD. Read here.
a country’s current account will be affected positively or negatively by the
- In theory, low interest rate
increase aggregate demand only when global demand is elastic.
- Low interest rate will lead to
- Countries with high proportion of
spender over saver will benefit more.
- There is no certainty how Interest
rate changes will affect a country’s current account.