Rates or interest rates are the price paid for the money of a loan, credit or other operation over a period of time. For example, when borrowing money from a bank, the amount must be returned plus the agreed percentage of interest. The concept also refers to the amount that banks pay their clients to invest their capital. In that sense, the rate below zero, which is paid for lending or depositing money, is called “negative interest.”
The factor most related to interest rates is the market itself. The lower the rates, the greater the demand for financial resources, and the higher the rates, the less demand there will be. Meanwhile, if rates rise, the money supply will increase, and if rates fall, it will decrease. Other factors related to interest rates are the liquidity premium, inflation or public debt. In any case, the central banks, in charge of monetary policy, establish the official interest rate in each country. The Federal Reserve or the European Central Bank, for example, set the rate in the United States and the European Union, respectively. Within this framework, there are different rates for mortgages or bank loans.
From Rome to monetary policy
Interests have existed in Europe at least since Ancient Rome. Later Christianity linked them to the sin of usury, which left the Jews as moneylenders in medieval Europe. However, the need to finance wars and Protestantism made monarchies more flexible. In the following centuries, the interests attracted the attention of early economists and authorities.
Finally, capitalism and the first central banks began to regulate interest rates. The Bank of England decided to raise them during the Napoleonic Wars to reduce loans and avoid greater debt due to the rise of trade. By using rates in its monetary policy, it set a precedent for the central banks of other countries, which began to modify them according to needs.
On the one hand, in periods of low investment and consumption, authorities reduce interest rates to increase the demand for money, thus increasing money in circulation and boosting the economy. On the contrary, during inflation, that is, a general increase in prices, interest rates rise to lower the demand for money, although the risk of a recession increases.
Interest rates in times of crisis
Along these lines, central banks have also varied interest rates in crisis situations. Germany, for example, reduced them in its hyperinflation at the beginning of the interwar period, but the measure ended up devaluing the currency. When he tried to raise rates it was too late, and in the end he faced the crisis with a new currency, the ‘safe mark’.
At the end of the decade, in 1929, the world economy faltered with the crash of the New York Stock Exchange. The Federal Reserve had kept rates low as the financial bubble grew in previous years, until the rise to almost 15% led from an excess to a shortage of liquidity. Already in the 1980s, the United States reached rates of 20% to reduce the effects of the previous “great inflation.”
Another notable case is Japan. After the bursting of the financial and real estate bubble in 1990, interest rates were raised to contain inflation. However, that same year it reduced them because families and creditor entities could not pay debts or loans. The economy continued to stagnate, and in 2001 the Bank of Japan promoted a zero rate policy until 2006.
Lehman Brothers, pandemic, Ukraine
Interest rate changes in one country have also affected others, such as in the global financial crisis of 2008. Reductions in the United States and other countries led to a massive purchase of mortgages with a high risk of default. With the bankruptcy of investment banks such as Lehman Brothers, the subsequent increase in rates ended up making mortgages unaffordable for citizens.
In 2022, a new period of inflation is occurring due to the lack of supplies as a result of the covid-19 pandemic and the war in Ukraine. On this occasion, the fear that inflation will increase and be maintained has already led the Federal Reserve and the European Central Bank to raise their respective interest rates by 0.75% and 0.25%.