Economics: What Determines Interest Rates

what determines interest rates:

it has long been assumed that the government drives interest rates. for example, Base Rate is determined by government institution and this is still closely followed. is the government really in charge anymore, now in the early 21st Century AD?

up to recently, as and when the Base Rate was moved, private banks and the bond market would follow suit, within a day in an orderly manner, without the question of differing demand and supply for different financial products, be it money in the bank, yield assets, or revolving credit, or whatever the product was, becoming an issue.

the natural mechanism was like thus, the Prime Rate or Base Rate was adjusted, if you like, higher, so that the government trying to exert control over inflation, by reducing demand generally and in particular for money, decreased lending to private banks. private banks then increased their savings rates to compensate for this and bring in borrowing from private individuals. private individuals would then favour bank savings over bonds and thus bond yields would go up as well. has the government now lost control over general interest rates in the economy?

many people may have multiple borrowing products, be they property mortgages, revolving credit like credit cards, etc. any cursory research on the web shows that these interest rates vary widely. demand and supply for credit is often the main determinant of the particular interest rate. concern over debt repayment is another.

what determines demand for any borrowing product? the easiest to obtain may make it the most expensive. mortgages might be hard to get, while anyone in formal employment could get a credit card. it is as if there are invisible barriers to obtaining credit or loan sometimes.

how, for example, does demand for credit card debt drive government interest rates though? what is big demand in the economy anyway? high technology, tourism, social related services? the government may market bonds still and lend to private banks, but does it still play any role in the free market for those economic demands? older people are thought of as more cautious and why, they can't gain formal employment anymore yet still need an income source and bonds are often targeted to them. does traditional interest rate theory play any part for younger people? the credit card substitutes cash money. because credit card debt becomes expensive, people eventually prefer to save money, lowering private bank savings rates. as private banks can raise money from private individuals without recourse to borrowing from central government, the Base Rate must be lowered to compete with private bank interest rates.

ultimately though, from observing the consumer market, when a new product enters the market, and there is huge demand for it, this drives demand for money and thus raises interest rates, like the household machines the washing machine, the refrigerator, the computer, etc.

CLEARCHARGE