What does “0% interest rate” mean and how does it help the economy?
In:
Companies revenue goes bust because sales drop , government issues a line of credit at 0% interest to help alleviate the burden of costs the company needs to pay in the short term (I.e salaries).
Short term is the key word though, because on a macro economic scale this operation is causing the currency to devaluate , and as a consequence the overall price of importing increases (buying items sold in another currency)
The lower the interest rate, the more it entices people to take out loans for big items (cars, houses) and to spend using credit cards, and the economy is “healthy” if things are being bought and sold.
The FED loans out money to banks. They want the banks to go do something with this money and/or for them to behave themselves by punishing them for not having enough over-night cash as is the rules. The higher the overnight rate, the more incentive to play by the rules. The higher the longer-term loan/bond/whatnot rate is, the more the fed thinks the bank can make the money grow.
In a 0% scenario, they’re not looking for growth, they just want the banks to survive. The banks aren’t punished for not having enough cash on hand at the end of the night.
The standard theory is that individuals are rational with their money. Each person makes decisions to save for the future or spend in the present. To counter inflation, their savings must grow usually at some interest (zero risk like savings acct in bank) or returns on some kind of investment which means taking some investment risk. Lower interest rates means that
a) people will be less likely to save and more likely to spend as their savings are growing slower. This spending stimulates economy – buying cars, going to movies, eating out more etc.
b) people who still save will be more inclined to take risks in investments rather than accept a lower interest. The most common means of investing is in assets (shares, property etc) and this more buyers tends to push asset prices higher.
c) companies make similar decisions. With lower interest rates, companies will favor investments in productive capacity because even at lower profit margins it makes more sense to invest and borrow. This investment stimulates the economy (hiring more people, buying equipment etc)
The downside to very low interest rates is that too much increased spending leads to inflation where instead of getting more stuff for the spending, things just get more expensive. This is very bad for people with fixed incomes. A lot of the investments also get riskier which means it is now much more sensitive to any disruption.
Zero percent interest is a headline statement. For many years, it was thought that there could never be a state of zero interest, ie it was a theoretical limit rather than anything that could actually happen. The thinking was that if interest rates dropped too low, inflation would very quickly destroy the currency/economy and therefore make interest rates irrelevant.
Rule 2: recent/current events
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