Discuss some of the consequential economic impacts of high and rising rate of interest
Some of the consequential economic impacts of high and rising interest rates:
- Increased cost of public debt servicing – redemption of treasury bills and bonds the government involves paying back the principle sum plus interest.
- Non-performing loans/bad debts arising from existing loan agreements. – This tends to cripple the liquidity status of institutions, leading to cash flow crisis and possibly of a complete collapse. We have seen in Kenya the Central Bank imposing statutory management of some commercial banks with a view to reviving them; with some of these banks being liquidated where revival trials fail. A bank collapse means a lot in terms of loss of deposits of those with accounts, unemployment, tax revenue to the government etc.
- Disincentive to investment – increase in interest rate increases the cost of capital hence reducing capital formation, growth and development.
- Inflationary tendencies – a rise in interest rates tends to increase the general level of prices of goods and services, leading to reduced purchasing power and welfare standards.
- Rationalization of business operations with a view to cutting costs – one of the options taken is to retrench workers (the order of the day in Kenya), again increasing the general level of unemployment, poverty and purchasing power (effective demand)
- Credit squeeze – high and rising interest rates reduces the ability of banks and other financial institutions to create more credit (advance new loans from deposits net of the cash-ratio requirement) since the demand for loanable funds decreases