Interest rates are at the heart of most lending or borrowing transactions. They influence the cost of debt for individuals and businesses, and they determine how much income people earn from savings or investments.
A rise in interest rates can cause the cost of credit card debt, mortgages and student loans to increase. This can lead to less consumer spending, which can slow economic growth. When interest rates are high for a long time, they can trigger a recession by discouraging businesses and consumers from taking on risky debt.
When interest rates are low, the cost of borrowing is lower, and people are more likely to spend money. This stimulates the economy and leads to more investment in riskier assets like stocks, which can boost market growth and economic expansion. However, over time, low rates can lead to market disequilibrium and inflation.
When interest rates rise, it costs more to borrow and reduces people’s disposable income, which can curb consumer spending. Companies that sell household goods, such as appliance maker Whirlpool Corp. and retailers Kohl’s Corp. and Costco Wholesale Corp., tend to outperform during these periods. In addition, savings and money market accounts earn higher rates when the Federal Reserve raises them, which can boost bank profits. It’s important for savers and investors to understand how the effective annual interest rate (EAR) varies from the nominal or quoted rate. It takes into account factors like compounding, fees and the number of interest periods per year to calculate total income.