Yield curve is the term used to describe the variation in cost of borrowing over a period of time. Though there are different factors which decide lending considerations over different time spans, yet the common factor is that any change in interest rate anywhere along the curve can send a chain reaction over the rest of the line. A fine example of this behavior is the mortgage rate. At any point in time, when the interest rate looks to go southward, the entire chain of the yield curve will also tend to dip. The high disparity in overnight lending rates and the rates for a 10-year period signals a sharp increase in inflation. Alternately, it can also be perceived as a sign of the deteriorating creditworthiness of the government over the next 10 years.
The recent economic crisis has shown that when the government is forced to pay higher interest rate, it has no option but to dip into public finances. According to experts, the writing is already on the wall that for every dollar that the government collects in taxation, it will have to spend several times that amount toward interest on national debts in the coming years. This is exactly the sort of situation that pushes a country toward financial crisis.
Having seen the impact that increasing interest rate can have on the overall financial health of a country’s economy, it is important to understand the reasons that affect the rates. As in any dynamic market, the forces of demand and supply determine the rates. Inflation is of course the primary reason for increase in lending rates. Lenders secure their money by adding expected inflation value to the lending rates. As discussed earlier, long-term loans are by nature a risky instrument because of the uncertainty factor associated with it. As there are chances of default in payments, such term loans are charged higher rates of interest. Interest rate comparison among various lending instruments reveals that long-term loan lending rates are higher in any loan element.
Interest rate is the key driver in any free market economy. The subject is broad and complex. It has a direct impact on the personal living standard of individuals in any economy, and its proper management is vital to the sustenance of the financial health of a country.
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