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The Advantages of High Interest Rates

by
author image Ripa Ajmera
Ripa Ajmera has been writing for six years. She has written for ABCNews.com, General Nutrition Center (GNC), TCW Finance, Alliance for a New Humanity, Washington Square News and more. She was a Catherine B. Reynolds Scholar from 2006-2008 and graduated from New York University Stern School of Business with an Honors degree in Marketing.
The Advantages of High Interest Rates
A couple is talking to their financial adviser. Photo Credit Comstock Images/Stockbyte/Getty Images

Overview

Higher interest rates increase the cost of borrowing money, but they also raise the income of people who are dependent on retirement funds or bond portfolios for their income. While corporations resent that they have to pay more to finance factories or inventories with high interest rates, insurance companies sometimes decrease their policy premium prices. It may seem surprising, but there are actually significant advantages of high interest rates.

High Fixed Income

Insurance companies, educational endowments and retirement funds all benefit from having high interest rates, as do people who depend on bond investments for income. These funds, in addition to banks and other lending institutions, can reach target investment returns through having more conservative credit quality portfolios. During times of low interest rates, banks and funds become tempted to invest in low-quality credits to reach their income needs. During high interest rate times, however, they can lock in high loan and investment income by extending their maturities very far into the future.

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Incentive to Save

When a government bond or savings account pays a high interest rate, people feel more willing to save rather than spend their funds.

High Risk Reward

When U.S. Treasury securities pay a high interest rate, additional risks are rewarded well with premiums that have significantly higher rates of interest. During times when there are low interest rates, risk premiums also flatten.

Stronger Currency

Having higher interest rates in a country (especially the United States) easily attracts investments from different foreign countries. This strengthens the currency due to foreign buyers of the country’s bonds having to buy the currency in order to finish their purchase transactions. This thus places a higher demand on the currency, which enjoys a rise in value relative to currencies of other countries. Higher currency values decrease the price of imported goods, which also reduces the prices of food, fuel and consumer goods.

Lower Retiring Debt Cost

When a government has to issue bonds to create an economic stimulus (as the U.S. had to do in 2009), the higher interest rates of later years enable that country’s Treasury to buy back bonds that have much lower prices. For example, a 2-point rise in interest rates will decrease the bid on 30 year Treasury bonds from $250, from $1,000 to $750 per bond.

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References

Demand Media