How Would an increase in interest rates affect investment?
Would a business invest more or less if there was an increase in interest rates and why?
Also how does an increase in interest rates affect the value of the British Pound? Does it become more in value or less and why?
Thanks, this whole process of interest rates and investment confuses me alot!!
Answer:
Overall, businesses invest less when interest rates increase, because the cost of borrowing money increases. Much business investment is funded wholly or partially by credit. Moreover, an increase in interest rates means that companies often have to devote more resources to paying interest on their existing debts, which lowers the amount available for investment. This is a major reason why the stock market tends to decline on news of rate increases -- lower investment equals lower potential growth for businesses in the near future.
As for the British Pound, it depends on whose rates we are talking about. In general, when a country raises the interest rate for its currency, we'd expect that currency to gain in value relative to other currencies. This is because an increase in a currency's interest rate makes it more valuable to hold as an investment, due to the higher rates that banks pay on deposits, borrowers pay on bonds/loans, etc. When the currency becomes more valuable, demand for it should increase, and so its value (price) should go up. In real life, these relationships are not so clear cut; values often do shift in response to interest rate changes, but the value shifts usually lag behind the rate changes (sometimes for a few years), and other complicating factors can 'distort' the value that we would expect purely from interest rate effects.
Possibly slow it down, as people who have borrowed or want to borrow money will be faced with more money to repay because of the increase in the interest rate.
An increase in interest rates affects investment adversely as interest is a cost to investor. so he will demand less loan and subsequently invest less since the more is the loan the more is the cost to him.
An increase in interest will make pound dearer i.e. costlier, so the supply of British pound will be less in the money market and hence the value of it will become more.
--If the Bank of England increases the base rate of interest then high street banks and comercial banks will raise their interest rates (as they tend to borrow money from the Bank of England in order to lend it to customers). As a result, it becomes more expensive for businesses to lend money as they will have to pay back more money every month/year etc., therefore they are likely to cut back on investment and put any of their spare money into banks as the increase in interest rates will mean they will receive more if they put it into an account.
In answer to your second question:
--If the base interest rate goes up, then financial investors from abroad will put their money into British banks as they will make greater returns on it. As a result, the demand for sterling will increase because who can't put foreign currencies in British banks. This will shift the demand curve for sterling to the right, making it more expensive and so the exchange rate will increase, i.e. its value will increase.
Hope to have been of help.
Interest rates and Investment.
Say you are a businessman, your livelihood depends on borrowing money at a cost (interest) and investing it in a venture that should give your higher returns than the cost. Hence your profit. Now whether you build a factory and start producing stuff, or are trading or anything is immaterial. WHat matters is the difference between the cost of your funds and the returns.
Now if interest rates go up, then there are some potential projects that are no longer profitable. Hence these projects will not go ahead, investment falls.
On the other hand, if interest rates fall, then there ar eprojects that we borderline unprofitable and which are now profitable. So you invest more.
Interest Rates and the Value of the Pound.
Imagine you are say a French man who has a stack of Euros. You have a choice; put it in a Euro Fixed deposit for 6 months, or moving your money to the UK and investing in a British Fixed Deposit for 6 months. Now, 2 things matter most to you: 1 the difference in interest rates between France and the UK, 2 the difference in exchange rates now and 6 months down the road.
For example, say today, the interest rate in UK is 10% over 6mths and in France it is 21% over 6 months. The exchange rate today is 1 pound is worth 1 Euro. In 6 months, you expect 1 pound to be worth 1.1 Euros. Now where would you invest? Say you have 100 Euros. In france you would get 100*1.2=120 Euros. In UK you would get 100*1.1 pounds=110 pounds which in 6 months are worth 121 Euros. So you wouldn't mind whether you invest in UK or France, in 6 months you expect to get the same number of Euros back, 121 Euros.
Now let the interest rate in the UK go up. Immediately that means that putting your Euros in UK Fixed Deposit is more profitable than in France. Therefore, you, and investors like you will immediately want to buy Pounds and Sell Euros so you can invets in the UK. The relative value of the pound today goe sup vis-a-vis the Euro, the pound appreciates.
If UK interest rates went down, people in the UK would move their funds to France and the pounds would lose value vis-a-vis the Euro, that is the pound depreciates.
The final point I'd like to make is that it doesn't matter which interest rates you are looking at because they are quite closely linked. For example, if the interest on your savings account goes up, that means that the interest on loand you ahve also go up, else the bank would go bankrupt.
Hope that helped clear the confusion.
Clearly an increase in interst rates will, in general, decrease investment as the cost of borrowing increases eg debt repayment.
For a comprehensive explanation you need to look to an economics text book for an investment model. Also the Solow Model in Steady State (and the golden rule) can put this in to the context of economic growth.
You must remember that the Savings Rate = Investment in an economy and that economic growth can only come from technological progress.
Also a change in interest rates leads to capital flight (rates up) or capital inflows. This will change the demand supply dynamics in an economy an accordingly alter exchange rates.
More Questions and Answers:
More Questions and Answers:
food prices comparison site?
Does Small and Medium Enterprises help to promote economic growth?
suggest me a research topic"problems related to rural agriculture with credit availability from institutions"?
how do you stop being a slave to money and start living?
Is Bureaucracy relevant in the 21st century?
What do you think about the European Union- México Free Trade Agreement ?
what is a mixed economy?
What is the economic impact of River Blindness on the Sub-African Economy?
Who gets more welfare in the United States? Businesses or poor people?
Also how does an increase in interest rates affect the value of the British Pound? Does it become more in value or less and why?
Thanks, this whole process of interest rates and investment confuses me alot!!
Answer:
Overall, businesses invest less when interest rates increase, because the cost of borrowing money increases. Much business investment is funded wholly or partially by credit. Moreover, an increase in interest rates means that companies often have to devote more resources to paying interest on their existing debts, which lowers the amount available for investment. This is a major reason why the stock market tends to decline on news of rate increases -- lower investment equals lower potential growth for businesses in the near future.
As for the British Pound, it depends on whose rates we are talking about. In general, when a country raises the interest rate for its currency, we'd expect that currency to gain in value relative to other currencies. This is because an increase in a currency's interest rate makes it more valuable to hold as an investment, due to the higher rates that banks pay on deposits, borrowers pay on bonds/loans, etc. When the currency becomes more valuable, demand for it should increase, and so its value (price) should go up. In real life, these relationships are not so clear cut; values often do shift in response to interest rate changes, but the value shifts usually lag behind the rate changes (sometimes for a few years), and other complicating factors can 'distort' the value that we would expect purely from interest rate effects.
Possibly slow it down, as people who have borrowed or want to borrow money will be faced with more money to repay because of the increase in the interest rate.
An increase in interest rates affects investment adversely as interest is a cost to investor. so he will demand less loan and subsequently invest less since the more is the loan the more is the cost to him.
An increase in interest will make pound dearer i.e. costlier, so the supply of British pound will be less in the money market and hence the value of it will become more.
--If the Bank of England increases the base rate of interest then high street banks and comercial banks will raise their interest rates (as they tend to borrow money from the Bank of England in order to lend it to customers). As a result, it becomes more expensive for businesses to lend money as they will have to pay back more money every month/year etc., therefore they are likely to cut back on investment and put any of their spare money into banks as the increase in interest rates will mean they will receive more if they put it into an account.
In answer to your second question:
--If the base interest rate goes up, then financial investors from abroad will put their money into British banks as they will make greater returns on it. As a result, the demand for sterling will increase because who can't put foreign currencies in British banks. This will shift the demand curve for sterling to the right, making it more expensive and so the exchange rate will increase, i.e. its value will increase.
Hope to have been of help.
Interest rates and Investment.
Say you are a businessman, your livelihood depends on borrowing money at a cost (interest) and investing it in a venture that should give your higher returns than the cost. Hence your profit. Now whether you build a factory and start producing stuff, or are trading or anything is immaterial. WHat matters is the difference between the cost of your funds and the returns.
Now if interest rates go up, then there are some potential projects that are no longer profitable. Hence these projects will not go ahead, investment falls.
On the other hand, if interest rates fall, then there ar eprojects that we borderline unprofitable and which are now profitable. So you invest more.
Interest Rates and the Value of the Pound.
Imagine you are say a French man who has a stack of Euros. You have a choice; put it in a Euro Fixed deposit for 6 months, or moving your money to the UK and investing in a British Fixed Deposit for 6 months. Now, 2 things matter most to you: 1 the difference in interest rates between France and the UK, 2 the difference in exchange rates now and 6 months down the road.
For example, say today, the interest rate in UK is 10% over 6mths and in France it is 21% over 6 months. The exchange rate today is 1 pound is worth 1 Euro. In 6 months, you expect 1 pound to be worth 1.1 Euros. Now where would you invest? Say you have 100 Euros. In france you would get 100*1.2=120 Euros. In UK you would get 100*1.1 pounds=110 pounds which in 6 months are worth 121 Euros. So you wouldn't mind whether you invest in UK or France, in 6 months you expect to get the same number of Euros back, 121 Euros.
Now let the interest rate in the UK go up. Immediately that means that putting your Euros in UK Fixed Deposit is more profitable than in France. Therefore, you, and investors like you will immediately want to buy Pounds and Sell Euros so you can invets in the UK. The relative value of the pound today goe sup vis-a-vis the Euro, the pound appreciates.
If UK interest rates went down, people in the UK would move their funds to France and the pounds would lose value vis-a-vis the Euro, that is the pound depreciates.
The final point I'd like to make is that it doesn't matter which interest rates you are looking at because they are quite closely linked. For example, if the interest on your savings account goes up, that means that the interest on loand you ahve also go up, else the bank would go bankrupt.
Hope that helped clear the confusion.
Clearly an increase in interst rates will, in general, decrease investment as the cost of borrowing increases eg debt repayment.
For a comprehensive explanation you need to look to an economics text book for an investment model. Also the Solow Model in Steady State (and the golden rule) can put this in to the context of economic growth.
You must remember that the Savings Rate = Investment in an economy and that economic growth can only come from technological progress.
Also a change in interest rates leads to capital flight (rates up) or capital inflows. This will change the demand supply dynamics in an economy an accordingly alter exchange rates.
The answers post by the user, for information only, FunQA.com does not guarantee the right.
More Questions and Answers:
More Questions and Answers: