As explained in an earlier post, interest rates have major effect on the housing market. I would like to take you through the journey of finding out what causes the interest rates to rise and fall.

Who is doing it?

First thing we need to understand is that interest rates are controlled by humans and not by a human looking fancy machines with superficial algorithms, or not yet. Until Cylons take over, the people that run the monetary authority of a country, a.k.a. central bank is responsible for making a decision on whether the interests rates are going to go up or down. The following are examples of such monetary authorities.

  • Australia (Reserve Bank of Australia)
  • Canada (Bank of Canada)
  • China (People’s Bank of China)
  • England (Bank of England)
  • Europe (European Central Bank)
  • Singapore (Monetary Authority of Singapore)
  • USA (Federal Reserve)
To ensure that the decisions made by the central bank is not politically motivated, they are neither state-owned nor directly regulated by government, parliament or another elected body. The government and the legislative bodies do still have limited control as defined in the Reserve Bank Act 1959.

How are they doing it?

The primary function of a central bank is to manage the nation’s money supply and acting as a lender of last resort to the banking sector during times of financial crisis or if a bank struggles to pay its debt.

Ok, so the central bank has two jobs, but which one is affecting the interest rates? The former. How so? By applying Monetary policy, a process the central bank uses to manage the supply of money.

Before we dive into the nitty-gritty of the monetary policy, lets come to a basic understanding about the money supply. Money supply is the total amount of monetary assets available in an economy at a specific time.

Monetary assets being currency (banknotes and coins) and bank money (the balance held in checking accounts and savings accounts), where bank money plays the largest part of the money supply in developed nations.

Economy consists of the production, distribution or trade, and consumption of limited goods and services by different agents. Agents being individuals, businesses, organizations, or governments.

What we understand from this is that money supply is endogenous, as in it is determined by the workings of the economy and not by the central bank, which is why central bank applies the monetary policy to manage it. If they don’t manage it, then that could have an ill effect on the nation’s currency value. So goal of the monetary policy is to promote economic growth and stability.

It seems monetary policy is what yo-yo’s with the interest rates for the greater good.

More on Monetary Policy.


2 thoughts on “Rise and Fall of the Interest Rates

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