According to Finweb.com, interests rates are "the amount received in relation to an amount loaned." These rates are expressed as a percentage, or "a ratio of dollars received per hundred dollars." Interest rates change often, but many are unaware what causes these rates to change. Knowing the various factors that cause daily interest rates to change can help you better understand finance and economics.
The Economy
The U.S. economy is an accurate reflection of how interest rates will fluctuate because of its effect on citizens of the country. If the economy is in a good state, citizens will generally be employed and, because of that, banks will have more money. The demand for money will also increase because of a lower supply, so more loans will be taken out, more credit cards will be used and more mortgages will be taken. This causes interest rates to increase. If the opposite happens--if the economy is in a poor shape--money will be in higher supply, so interest rates will decrease.
Inflationary Pressures
When inflation occurs, money is worth less. Since interest rates are often fixed, the money a lender receives becomes worth less. When this happens, lenders often create an inflationary premium, which is a demand for a higher interest rate. When deflation happens, the opposite occurs--money is worth more, so the interest rate decreases.
Actions of Federal Government
The U.S. government is the largest borrower in the country. Because of this, the government is able to claim funds that are available in the market. If the government takes out a great deal of money, it will cause interest rates to rise. If it pays back a lot of its debt, interest rates decrease. This happens because government debt is an investment, due to its high credit rating.
International Forces
Foreign countries loan money and domestic products to the United States on a daily basis, which pushes interest rates down. When less money and products come from our own country, there is more money available, similar to if unemployment is high. This will cause fewer loans to be taken out and more interest rates to drop. If less domestic products and money are coming into the country from the rest of the world, interest rates will increase.
The Dollar
The value of the U.S. dollar fluctuates constantly compared to the rest of the currency in the world. This fluctuation, according to Finweb.com., is "essential for domestic and international stability." If the value of the dollar increases, interest rates will decrease; conversely, if the value of the dollar decreases, interest rates will increase.
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