The Federal Reserve has cut its key interest rate from 1.5% to 1% in a widely expected move, as it aims to avoid a possible US recession.
The question arises
- Why do Central Bank cuts interest rates?
- What is the impact of interest rate cuts?
Interest rates are reduced in order to increase the aggregate demand in the economy.
Now the question arises 'How aggregate demand rises?'
- Loans become cheap, people will take more loans to buy houses and cars etc.
- Businesses will also find it the best time to go in for expansion plans, because the loans are cheap.
- As the interest rates are very low people will not put their money in bank, and will find more lucrative investment opportunities. They would rather invest their money in businesses where there are better returns. Businesses will boost.
Now when the aggregate demand rises,
Market forces start acting. After a certain period of time if the supply will not be able to keep up with the rise in demand, prices will go up and cause inflation.
This is where the Central Bank has to be cautious and closely monitor the market.
