Reducing Interest Rates to Stimulate the Economy

The basic idea behind the monetary policy is that the lowest interest rates generate more consumption and more investment; therefore the following could be included in the cur of demand:

• Lowest interest rates stimulate spending of consumption by making it more attractive to get loans to buy things such as housing and a car.

• The lowest interest rates stimulate expense of investment and the businesses become profitable because a greater number of them have potential investment projects. In other words if the interest rates are at ten percent, the companies would only be willing to get money in a loan to invest in projects with return rates that are higher then ten percent. But if the interest rates fall to five percent, all the projects with return rates that are over five percent become variable, and this makes the company solicit more loans and start up on new projects.

When you try to think about how the monetary policy works, remember that actually, it is a very simple process that can be done in three steps. When the Federal Reserve wants to help out to increase the product, the next chain of events occurs:

• Buying of bonds from the government to increase monetary supply.

• The increase in the monetary supply makes the interest rates go down because the pressure on the bonds makes their price increase.

• The consumers and companies respond to smaller interest rates asking for more loans and using money to buy goods.

The difficult part is to remember the fact that an increase in the prices of bonds means lower interest rates. if it is difficult for you to remember that, don’t stress out about it because there are a lot of people and even an economist forgets.