Higher interest rates also means banks and financial institutions are willing to increase the interest they pay for savings accounts, because effectively when you deposit money in savings accounts, you are lending it to the bank. And when the population as a whole saves more, this again takes money out of the economic system and cools things down.
Rising interest rates have a secondary effect too.
When people see interest rates rising, or think they will, they begin to feel that the economy isn’t doing too well and this makes them nervous about losing their jobs, or their ability to win new orders to keep their factories going. When this happens, consumers tend to hold onto their money in case they need it, whilst businesses put off making any large investment decisions to make sure they have cash in the bank to see them through bad times.
So, interest rates don’t just affect us directly through how much we have to pay for our mortgages and loans, but also indirectly, by influencing how we think about the future, which causes us to change our behaviour.
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