Question

What impact do increased interest rates have on consumption and savings?

Answer 1

Wow, very complex.. I'd say that it mostly affects higher price items that are obviously linked to the interest rate, like house buying.. From there, it's a trickle down domino effect, and it gets very complex.. I guess you could say it affects everything in the economy, because once house prices go up from the interest rates going up, then that affects the construction industry (negatively), and that diminished buying power affects other industries, etc., etc.,. Also when the interest rate goes up, there's more money to be made in safer investments like bonds, so less money is invested that ends up into the hands of businesses and entrepenuers, and this can spark recession.. During the end of the Carter administration recession, people were earning around 21% by just stashing their money, so why would they risk it on the stock market?

Answer 2

This is actually easily. . Interest rates go up, money saved in a bank or term deposit/bond now earns more money (interest) - So people have more incentive to save money.. . Likewise the cost of borrowing money has increased, so people have a dis-incentive to borrow money, reducing consumption (you will buy that car on hire purchase later, because its too expensive now..). . It decreases consumption and increases savings, which is what it is meant to do.. . The central bank (FED in the USA) controls inflation by raising interest rates. Inflation is mostly caused by consumers wanting to spend money faster than goods are being produced (so price goes up, the economy hardly grows and inflation occurs - FED raises interest rates, people spend less, save more, and less inflation occurs). . At higher price levels in the economy, Growth needs to be caused by more production (productivity) because this causes higher growth levels without the high inflation that hurts the economy in the long run. . I have gone well beyond what you have asked, but it might help you understand it some more, and the reasons behind it.